Subsabsection: Adverse Selection And Moral Hazard Problem: Case Study
\subsubsection{Adverse Selection and Moral Hazard Problems}
The adverse selection problem can best be described as following: insiders usually have more details about the company and its real value than outsiders and this has an influence on the quality of the firms that go public (Leland and Pyle, 1977; Gill de Albornoz and Pope, 2004)). This is also called the lemons problem (leland and Pyle, 1977). As already discussed, these asymmetry costs could lead to IPO underpricing (Rock, 1986; Welch, 1989). Investors have to gather information, and this is a costly process, so they will only accept lower prices (Draho, 2004). This is especially the case for an IPO that targets many investors (Chemmanur and fulghieri, 1999). Maug (1999) calls this …show more content…
In imperfect credit markets, entrepreneurs can not borrow, so they have to sell part of their shares through an IPO to gain liquidity (Pagano, 1993). An IPO creates liquidity for the stock, so it is obvious that this is cheaper than actively searching for a counterpart (Gill de Albornoz and Pope, 2004). Gill de Albornoz and Pope (2004) also argue that the liquidity of a company’s shares is a function of its trade volume, so only large companies are able to benefit from liquidity gains. This leads again to the argument that larger firms are more likely to go public.
\subsubsection{Easing Borrowing Constraints}
Companies with already a great amount of debt may have difficulties to raise additional debt because the banks take the increasing risk into account (Gill de Albornoz and Pope, 2004). But going public can increase the competitiveness among the firm’s lenders and creates a larger pool of financial supplies (Rajan, 1992). With this in mind, we would expect that firms with a higher leverage ratio and thus more investment opportunities and high growth (Myers, 1977), are more likely to go public. Fischer (2000) also expect companies in new industries to be more likely to go public as those companies face a lot of uncertainty, so they might be unable to get finance from traditional
The adverse selection problem can best be described as following: insiders usually have more details about the company and its real value than outsiders and this has an influence on the quality of the firms that go public (Leland and Pyle, 1977; Gill de Albornoz and Pope, 2004)). This is also called the lemons problem (leland and Pyle, 1977). As already discussed, these asymmetry costs could lead to IPO underpricing (Rock, 1986; Welch, 1989). Investors have to gather information, and this is a costly process, so they will only accept lower prices (Draho, 2004). This is especially the case for an IPO that targets many investors (Chemmanur and fulghieri, 1999). Maug (1999) calls this …show more content…
In imperfect credit markets, entrepreneurs can not borrow, so they have to sell part of their shares through an IPO to gain liquidity (Pagano, 1993). An IPO creates liquidity for the stock, so it is obvious that this is cheaper than actively searching for a counterpart (Gill de Albornoz and Pope, 2004). Gill de Albornoz and Pope (2004) also argue that the liquidity of a company’s shares is a function of its trade volume, so only large companies are able to benefit from liquidity gains. This leads again to the argument that larger firms are more likely to go public.
\subsubsection{Easing Borrowing Constraints}
Companies with already a great amount of debt may have difficulties to raise additional debt because the banks take the increasing risk into account (Gill de Albornoz and Pope, 2004). But going public can increase the competitiveness among the firm’s lenders and creates a larger pool of financial supplies (Rajan, 1992). With this in mind, we would expect that firms with a higher leverage ratio and thus more investment opportunities and high growth (Myers, 1977), are more likely to go public. Fischer (2000) also expect companies in new industries to be more likely to go public as those companies face a lot of uncertainty, so they might be unable to get finance from traditional