Abolishing IPOs and Harnessing Private Markets in the Public Good

The following post comes to us from Adam C. Pritchard, Professor of Law at University of Michigan.

In my paper, Revisiting “Truth in Securities Revisited”: Abolishing IPOs and Harnessing Private Markets in the Public Good, I explore the possibility of doing away with initial public offerings. In their place, I propose an expanded system of company registration under which companies would have to trade in private markets for a seasoning period, with mandatory disclosure, before they would be allowed to sell their shares to the public at large. I argue that such system would promote not only efficient capital formation, but also investor protection.

Under the current regime, companies can stay private until one of three triggering events occurs: 1) the company lists its shares for trading on a securities exchange; 2) the company makes a registered public offering; or 3) the company exceeds 2,000 shareholders. Typically, companies trigger public company status through an initial offering of shares, with simultaneous listing of those shares on an exchange. The decision to make an initial public offering, however, is frequently made because the company is pushing the limit on the number of shareholders as a result of prior private issues to employees and early-round investors.

The evidence consistently shows that IPOs are inefficient, combining (on average) short-term underpricing with long-term underperformance. I argue that this combination results from the difficulties of determining the correct valuation an unknown company that is making public disclosures for the first time. Without the benefit of a trading market to process that disclosure and develop a consensus valuation, mispricing in the public offering is inevitable; the market for IPOs falls far short of the ideal of the efficient capital market hypothesis. Moreover, the influx of retail traders into the secondary market, fueled by speculative enthusiasm, drives the trend toward long-term underperformance. Thus, the current system of IPOs has neither efficient capital formation nor investor protection to recommend it.

I propose a two-tier market system to replace IPOs as the avenue for companies to transition from public to private. The lower tier would be a private market restricted to accredited investors along the lines of SecondMarket and SharesPost. Only after a company had reached a minimum market capitalization or trading volume in that private market would it be eligible for elevation to the top-tier public market. That top tier would have unlimited access for institutional and retail investors alike. Issuers that chose to make the transition to the public market would be required to make public company disclosures – the current 10-K – followed by 10-Qs for an appropriate seasoning period. During that seasoning period, trading would be limited to the private market. The seasoning period in the private market would allow investors to arrive at a a consensus valuation of the company informed by mandatory disclosure. Only after the seasoning period would the issuer be allowed to sell shares to the public at large. Investors would then also be free to resell their shares to retail investors.

The full paper is available for download here.

Post a comment or leave a trackback: Trackback URL.

2 Trackbacks

  1. […] full article via Abolishing IPOs and Harnessing Private Markets in the Public Good — The Harvard Law School Forum o…. Share OptionsPrintEmailMoreFacebookLinkedInStumbleUponTwitterPinterestRedditDiggTumblrLike […]

  2. […] HLS Forum on Corporate Governance and Financial Regulation: Abolishing IPOs and Harnessing Private Markets in the Public Good – In this thought provoking piece, University of Michigan Law School Professor Adam […]

Post a Comment

Your email is never published nor shared. Required fields are marked *


You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

  • Subscribe

  • Cosponsored By:

  • Supported By:

  • Programs Faculty & Senior Fellows

    Lucian Bebchuk
    Alon Brav
    Robert Charles Clark
    John Coates
    Alma Cohen
    Stephen M. Davis
    Allen Ferrell
    Jesse Fried
    Oliver Hart
    Ben W. Heineman, Jr.
    Scott Hirst
    Howell Jackson
    Robert J. Jackson, Jr.
    Wei Jiang
    Reinier Kraakman
    Robert Pozen
    Mark Ramseyer
    Mark Roe
    Robert Sitkoff
    Holger Spamann
    Guhan Subramanian

  • Program on Corporate Governance Advisory Board

    William Ackman
    Peter Atkins
    Joseph Bachelder
    John Bader
    Allison Bennington
    Richard Brand
    Daniel Burch
    Richard Climan
    Jesse Cohn
    Isaac Corré
    Scott Davis
    John Finley
    David Fox
    Stephen Fraidin
    Byron Georgiou
    Carl Icahn
    Jack B. Jacobs
    Paula Loop
    David Millstone
    Theodore Mirvis
    James Morphy
    Toby Myerson
    Morton Pierce
    Barry Rosenstein
    Paul Rowe
    Rodman Ward