Investment dynamics and financial constraints in IPO firms

Abstract

We join research in entrepreneurship and corporate fi nance to investigate fi nancial constraints on investments by IPO INTRODUCTIONFirms' competitiveness and growth prospects turn on their abilities to seek out business opportunities, access resources, and make strategic investments (e.g., Ghemawat, 1991;Hitt et al., 2001). Information plays a critical role in shaping fi rm investment and its returns since fi rms holding privileged information are able to pursue profi table business opportunities and obtain competitive advantages when imperfections exist in factor markets (e.g., Kirzner, 1973;Barney, 1986). If markets for obtaining fi nancial resources are assumed to be perfect, fi rms can theoretically make an investment based solely on its marginal profi tability (e.g., Modigliani and Miller, 1958). However, given imperfections that arise in fi nancial and factor markets, important and interesting connections surface between fi rms' investment and fi nancial decisions. Firms can then confront trade-offs between the competitive advantages certain investments might create and the fi nancing costs of pursuing opportunities. The result can be that fi nancial constraints can become more serious and restrict fi rms' ability to make certain investments.In previous corporate fi nance research, the term fi nancial constraints has been used to refer to the problem whereby a fi rm foregoes investments because it lacks access to external fi nancial resources and does not have internal funds to pursue a profi table opportunity (e.g., Stein, 2003). As will be discussed later, such constraints are a consequence of information asymmetries in capital markets (e.g., Myers and Majluf, 1984). In a theoretical argument analogous to Akerlof's (1970) opportunities due to asymmetric information. The fi rm will, therefore, pass up certain investment opportunities that are costly to fi nance externally when the fi rm lacks internal cash fl ows from operations. Empirical studies testing the implications of analytical models of fi rm investment have produced evidence that fi rms' capital expenditures are indeed sensitive to their operating cash fl ows, after accounting for investment opportunities (e.g., Fazzari, Hubbard, and Petersen, 1988). This research on the antecedents of fi rm investment also has important parallels with studies by strategy and management scholars on the important role fi nancial slack plays in determining fi rm outcomes such as innovation (e.g., Kim, Kim, and Lee, 2008) and performance (e.g., Bromiley, 1991). A separate, but also substantial, stream of research in entrepreneurship has suggested that fi nancial constraints will be particularly problematic for some types of fi rms. As one example, Baker and Nelson (2005) described possible approaches small fi rms in resource-poor environments might consider, including bricolage-making do with means and resources at hand (Lévi-Strauss, 1967)-or resource-seeking behaviors, such as attempting to raise capital (e.g., Berger and Udell, 1994). As another example, new...

Family Firm Governance and Financial Policy Choices in Newly Public Firms

“…For instance, preference for the “quiet life” as discussed in Bertrand and Mullainathan (), or risk aversion on the part of influential shareholders such as family owners, can manifest itself in the form of reluctance to raise external capital required to adequately fund firm investment opportunities. Consistent with this notion, in the context of IPO firms, research suggests that despite strong growth prospects and the opportunity to raise capital subsequent to going public, firms tend to remain financially constrained, particularly in the case of younger firms and/or those with a greater proportion of intangible assets (Chaddad & Reuer, ). We further evaluate whether family ownership is another factor that contributes to IPO firms remaining financially constrained despite the enhanced ability to raise capital subsequent to going public.…”

Internationalization and the IPO performance of new ventures

“…While Sullivan (1994) suggests that the degree of internationalization is a multidimensional construct including asset and diversity-based measures, FSTS is an appropriate measure for new ventures. Asset-based measures may be inappropriate for young ventures in knowledge-intensive technology industries whose main assets may be intangible (e.g., specialized knowledge and skills of staff), and often underpin an IPO venture's competitive advantage (Chaddad & Reuer, 2009). International diversity (operating in more than one foreign environment) is unusual in small American companies (International Trade Administration, 2003), and establishment of foreign subsidiaries may be beyond the commitment a young venture is able to make, as the initial entry modes for new ventures are usually low-control (e.g., export or licensing) in nature.…”

“…Such information asymmetries may increase as new ventures move from opportunistic, low levels of international sales (e.g., exporting in response to a foreign query) to more intensity, higher dependency, and greater commitment to foreign sales. Such information asymmetries between IPO ventures and capital providers help explain why some IPO ventures experience greater financial constraints (Chaddad & Reuer, 2009) due to IPO performance.…”

“…These assets are often at the root of an IPO company's competitive advantage (Chaddad & Reuer, 2009). Internationalization may increase the risk of appropriation of the intellectual property by foreign partners or competitors and this risk may increase as exposure to more markets, customers, partners, and suppliers increases as international intensity increases.…”

CEO power, product market competition and the acquisition motive for going public

“…In the neoclassical view, mergers represent an efficient response to industry shocks (Mitchell and Mulherin, 1996;Jovanovic and Rousseau, 2002). In such environments, IPO firms are not well positioned to withstand industry shocks and capitalise on valuable growth options as they tend to suffer from a 'liability of newness' as well as face significant financing constraints (Chaddad and Reuer, 2009). Competitive markets are more likely to suffer from demand and technology shocks as rival firms strive to achieve a competitive advantage.…”