Where have all the IPOs gone?

Larry Ribstein —  12 November 2011

Ritter, Gao and Zhu ask, Where have all the IPOs Gone?  Well, not to young men everywhere, but to the older men and women who run the big companies that have replaced public markets as the key venture capital exit. Here’s the abstract:

During 1980-2000, an average of 311 companies per year went public in the U.S. Since the technology bubble burst in 2000, the average has been only 102 initial public offerings (IPOs) per year, with the drop especially precipitous among small firms. Many have blamed the Sarbanes-Oxley Act of 2002 and the 2003 Global Settlement’s effects on analyst coverage for the decline in U.S. IPO activity. We offer an alternative explanation. We posit that the advantages of selling out to a larger organization, which can speed a product to market and realize economies of scope, have increased relative to the benefits of remaining as an independent firm. Consistent with this hypothesis, we document that there has been a decline in the profitability of small company IPOs, and that small company IPOs have provided public market investors with low returns throughout the last three decades. Venture capitalists have been increasingly exiting their investments with trade sales rather than IPOs, and an increasing fraction of firms that have gone public have been involved in acquisitions. Our analysis suggests that IPO volume will not return to the levels of the 1980s and 1990s even with regulatory changes.

Why has this happened?  The authors suggest that “there has been a structural change over time that has increased the profitability of large firms that can realize economies of scope, speed products to market, and realize economies of scale in information technology.” For example, Apple could “assign a veritable army of engineers to rapidly implement new technologies into its consumer electronics products, such as the iPad, iPod, and iPhone. * * *No small independent company could implement new technology so rapidly and sell tens of millions of units to consumers in a matter of months.”

On the demand side, “the internet has made comparison shopping easier for consumers * * * Increased speed of communication thus leads to both a greater advantage from implementing new technology quickly, and a greater opportunity cost of waiting.”

If the authors are right, the future of innovation is mainly in large firms. (Not entirely:  the data doesn’t exclude the possibility of more Facebooks, Zyngas and Groupons.) Small firms might come up with the initial ideas, but big firms will become more influential in determining which ideas succeed. 

The question then becomes whether the structure of big firms will adapt to their new role by staying entrepreneurial and receptive to innovation. Big firms tend to get bureaucratized and complacent.  We have needed new blood to shake up the incumbents.  Big firms will have to offer decentralized decision-making and innovative compensation policies (insider trading?). 

Here is where deregulation could be useful:  not in determining the number of IPOs, but in letting today’s big firms offer the incentive structures and flexibility that enabled them to grow up to be what they are today.

Larry Ribstein

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Professor of Law, University of Illinois College of Law

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