How do disclosure requirements influence a private firm’s decision to go public? This is an important question for regulators and corporate finance professionals, given current debate about how much information private firms should have to disclose. Conceptually, public disclosure requirements for private firms can lead to greater exposure of the firm’s confidential and proprietary information. Keeping this information out of the hands of competitors is a major factor that pushes firms to stay private. However, the introduction of laws that compel firms to disclose their private information essentially strips away this advantage. As a result, one would expect the ability to withhold proprietary information to no longer be a factor in a firm’s decision on whether to undertake an initial public offering (IPO).  Yet the limited public disclosure requirements of U.S. private firms, and the scarcity of data on private firms, make it very difficult to gauge the effect of increased public disclosure requirements on a firm’s propensity to go public.

In our recent paper “Do Mandatory Disclosure Requirements for Private Firms Increase the Propensity of Going Public”, we empirically examine this question using detailed firm-level data of the biopharmaceutical (biopharma) industry surrounding a shock to firms’ disclosure requirements. In 2007, the U.S. government passed the Food and Drug Administration Amendments Act (FDAAA), which required that all firms engaging in clinical research studies involving humans to disclose the results of their Phase II and later clinical trials in a public database, ClinicalTrials.gov. This essentially allowed firms to observe and monitor the progress of their competitors’ projects.

To test for the effect of strengthened disclosure requirements on firms’ propensity to go public, we additionally exploit cross-sectional variation in firms’ project portfolios to provide variation in the treatment (i.e., the level of exposure to the law). In particular, because the law applies only to clinical trials that are in Phase II or later, the legislation has a greater effect on firms that have more such projects. We note that, in the biopharma industry, firms often go public even though the majority of their projects are in early stage development.

Using this source, we use a difference-in-differences specification to test for the effect of the enhanced disclosure requirements. We find that firms that are more affected by the legislation are also significantly more likely to go public post-reform. To explore more deeply whether this is due to the cost of disclosing proprietary information, we partition our sample based on whether the firm is in a competitive development area. We find that firms that faced more competitive pressure were also more likely to go public following the reform. As an additional test, we also partition the sample based on pre-FDAAA disclosure levels by firms, the reasoning being that firms that disclosed more frequently prior to the law are also less likely to be affected by proprietary disclosure costs. Consistent with our hypothesis, we find that firms that disclosed less information prior to the FDAAA were also more likely to go public after the law became effective.

We also examine how an affected firm’s transition to becoming public affected the company’s project choices. For example, due to potential agency frictions from becoming a public company, do firms alter their project portfolios in particular ways? Using a two-stage estimation procedure, we find that firms that went public due to the legislation are also significantly more likely to acquire outside projects, suspend projects in-house, and pursue less risky projects. These findings are consistent with firms’ pursuing external innovation and safer projects following an IPO.

This post comes to us from professors Cyrus Aghamolla and Richard T. Thakor at the University of Minnesota. It is based on their recent paper, “Do Mandatory Disclosure Requirements for Private Firms Increase the Propensity of Going Public?,” available here.