The Stock Market as a Screening Device and the Decision to Go Public

30 Pages Posted: 14 Apr 1998

See all articles by Tore Ellingsen

Tore Ellingsen

Stockholm School of Economics - Department of Economics; Norwegian School of Economics (NHH) - Department of Economics

Kristian Rydqvist

State University of New York at Binghamton - School of Management; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Abstract

We argue that many firms become publicly traded on a stock exchange as the first stage of a longer term divestment plan. Making a direct sale of unlisted stock may be associated with great adverse selection costs. The publicly listed stock price reduces adverse selection by aggregating the information of several investors, and this market valuation, rather than the cash infusion, could be the main benefit of an initial public offering. This theory provides a unified treatment of a whole range of empirical observations, in particular why initial owners frequently exit completely subsequent to an initial public offering (IPO) and why the number of stock market introductions increases with the stock price level. The model also reformulates the "sweet taste" explanation of IPO underpricing in a way which is consistent with recent evidence. Finally, we argue that the number of firms which go public is inefficiently large.

JEL Classification: G32, G14

Suggested Citation

Ellingsen, Tore and Rydqvist, Kristian, The Stock Market as a Screening Device and the Decision to Go Public. Available at SSRN: https://ssrn.com/abstract=75358 or http://dx.doi.org/10.2139/ssrn.75358

Tore Ellingsen (Contact Author)

Stockholm School of Economics - Department of Economics ( email )

P.O. Box 6501
Sveavagen 65
S-113 83 Stockholm
Sweden
+46 8 736 9260 (Phone)
+46 8 31 3207 (Fax)

Norwegian School of Economics (NHH) - Department of Economics

Helleveien 30
N-5035 Bergen
Norway

Kristian Rydqvist

State University of New York at Binghamton - School of Management ( email )

P.O. Box 6015
Binghamton, NY 13902-6015
United States
607-777-2673 (Phone)
607-777-4422 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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