384 Part Four Financing Decisions and Market Efficiency
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There comes a stage in the life of many young companies when they decide to make an initial
public offering of stock, or IPO. This may be a primary offering, in which new shares are
sold to raise additional cash for the company. Or it may be a secondary offering, where the
existing shareholders decide to cash in by selling part of their holdings.
Many IPOs are a mixture of primary and secondary offerings. For example, in 2014
Alibaba’s IPO raised a record $25 billion. About a third of the shares were sold by the com-
pany, but the remainder were sold by existing shareholders. Many of the biggest secondary
IPOs arise when a government sells its stake in a company. For example, in 2010 the U.S.
Treasury raised $20 billion by selling its holdings of General Motors common and preferred
stock. The same year the Chinese government raised a similar sum by the sale of the state-
owned Agricultural Bank of China.
IPOs raise cash for the company or the existing shareholders, but, as you can see from
Figure 15.2, there may be other motives for going public. For example, the company’s stock
price provides a readily available yardstick of performance, and allows the firm to reward the
management team with stock options. And, because information about the company becomes
more widely available, the company can diversify its sources of finance and reduce its bor-
rowing cost.
While there are advantages to having a market for your shares, we should not give the
impression that firms everywhere aim to go public. In many countries it is common for large
businesses to remain privately owned. For example, Italy has only about an eighth as many
listed companies as the U.K. although the economies are roughly similar in size.
BEYOND THE PAGE
mhhe.com/brealey12e
The largest U.S.
private companies
◗ FIGURE 15.2 Survey evidence on the motives for going public.
Source: J. C. Brau and S. E. Fawcett, “Evidence on What CFOs Think about the IPO Process: Practice, Theory and Managerial Implications,”
Journal of Applied Corporate Finance 18 (October 2006), pp. 107–117.
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59.4%
51.2%
49.1%
45.9%
44.1%
42.5%
32.2%
29.8%
27.6%
Debt is becoming too expensive 14.3%
Our company has run out of private equity
To attract analysts’ attention
To allow venture capitalists to cash out
To minimize our cost of capital
To allow one or more principals to diversify
personal holdings
To broaden the base of ownership
To enhance the reputation of our company
To establish a market price/value for our firm
To create public shares for use in
future acquisitions
CFOs who agree or strongly agree, %
15-2 The Initial Public Offering