The determinants of when and why private companies decide to go public through an initial public offering (IPO) is an important question with many policy implications. Anecdotally, one reason why firms decide to do an IPO is as a response to the actions of their rivals. For example, in the share-economy sector, Uber is said to have sped up its IPO plans after learning that Lyft would soon go public. In the cyber-security industry, Tenable reportedly sped up its IPO plans after hearing about the IPO of one of its close competitors, Zscaler. These sorts of “peer effects” among firms—where one firm takes an action in response to a similar action by a competitor—have been shown to be important to firm decision-making in other contexts, such as financial policy. However, systematic empirical evidence of this effect in the decision to go public has not been established.
In our paper, “IPO Peer Effects,” we explore this issue and provide empirical evidence that the IPO decision of a peer firm affects its competitors. A major challenge in this exercise is that it requires data on private firms—both those that go public and those that remain private—as well as the ability to identify close rivals among these firms. This is difficult because the financial statements and operating decisions of private companies are not publicly available. We are able to overcome this difficulty using data from the drug development industry, which affords us a number of advantages. First, there were hundreds of IPOs by private firms over our sample period. Second, we are able to employ very detailed data on the drug development portfolios of private firms in our sample, allowing us to precisely identify peers and competitors that are developing drugs in the same, narrow therapeutic category. Finally, the data and our empirical approach allow us to overcome many of the difficulties that are typically associated with studies that explore peer effects.
We find that private firms are significantly more likely to do an IPO when a close competitor has recently gone public. This result holds across a variety of specifications and after controlling for a variety of factors such as time and firm-fixed effects, market conditions, the number of IPOs, and the risk and size of the project portfolio. It also remains when accounting for other common shocks between firms.
We dig even further into these results to investigate the factors giving rise to this effect. First, we provide evidence that the effect is stronger for firms facing greater competition, suggesting that the effect comes from a competition: Going public gives a firms a competitive edge, and thus its rivals choose to initiate or accelerate their IPO plans and quickly go public in response. Second, we find that our result is centered around firms that are R&D competitors—firms that have drugs in development in the same therapeutic category—as opposed to product market competitors. This finding that a firm responds to an R&D rival that goes public suggests that the focal firm seeks to continue to compete by going public themselves.
In our final analyses, we explore whether these peer effects operate more broadly across funding opportunities for private firms in addition to IPOs. As an alternative to going public, private firms can obtain funding through venture capital (VC) or by being acquired by a larger firm. We find evidence of peer effects with VC funding, being acquired, and also more general funding peer effects combining these two methods and IPOs. However, when examining these peer effects more closely, we find that the scale of the funding source matters. In particular, VC funding peer effects are present only with relatively large VC funding rounds, and firms do not turn to VC funding when their peers are acquired or go public. In contrast, going public and being acquired are both significant responses to a peer’s obtaining any type of funding, with the strongest effects centering on firms choosing to go public as a response.
These results provide further evidence of the influence of competition: To remain competitive with their rivals, firms raise capital after seeing a close competitor do so. Moreover, this effect is salient for funding that provides large capital increases by competitors, and firms respond with sources that allow funding increases of their own. The results also provide evidence that firms are more inclined to go public than sell themselves or raise VC funding in response to a peer’s funding decision. This suggests that IPO funding has a particularly strong peer effect due to the magnitude of funding involved, which allows firms to maintain competitiveness in an effort to advance project development towards commercialization.
Overall, our results provide further evidence to enhance our understanding of the factors that drive firms toward funding markets and show that competitive pressures are important to understand and can lead to network reactions among firms.
This post comes to us from professors Cyrus Aghamolla and Richard T. Thakor at the University of Minnesota. It is based on their recent article, “IPO Peer Effects,” forthcoming in the Journal of Financial Economics and available here.