Onur Bayar

IPOs versus Acquisitions and the Valuation Premium Puzzle: A Theory of Exit Choice by Entrepreneurs and Venture Capitalists

We analyze a private firm’s choice of exit mechanism between initial public offerings (IPOs) and acquisitions, and we provide a resolution to the “IPO valuation premium puzzle.” The private firm is run by an entrepreneur and a venture capitalist (VC) (insiders) who desire to exit partially from the firm. A crucial factor driving their exit choice is competition in the product market: While a stand-alone firm has to fend for itself after going public, an acquirer is able to provide considerable support to the firm in product market competition. A second factor is the difference in information asymmetry characterizing the two exit mechanisms. Finally, the private benefits of control accruing to the entrepreneur post-exit and the bargaining power of outside investors versus firm insiders are also different across the two mechanisms. We analyze two situations: the first, where the entrepreneur can make the exit choice alone (independent of the VC), and the second, where the entrepreneur can make the exit choice only with the concurrence of the VC. We derive a number of testable implications regarding insiders’ exit choice between IPOs and acquisitions and about the IPO valuation premium puzzle.

Payout Policy under Heterogeneous Beliefs: A Theory of Dividends versus Stock Repurchases, Price Impact, and Long-Run Stock Returns

We analyze a firm’s choice between dividends and stock repurchases in an environment of heterogeneous beliefs and short sale constraints. We study a setting in which the insiders of a firm, owning a certain fraction of its equity and having a certain amount of cash to distribute to shareholders, choose between paying out cash dividends and buying back equity, as well as the scale of investment in their firm’s new project. Outside equity holders in the firm have heterogeneous beliefs about the probability of success of the firm’s project and therefore its long-run prospects; they may also disagree with firm insiders about this probability. We show that, depending on the beliefs of firm insiders versus outsiders, the firm may distribute value through cash dividends alone; through a repurchase alone; or through a combination of a cash dividend and a stock repurchase. We also show that, in many situations, it is optimal for firm insiders to underinvest in the firm’s positive net present value project and undertake a stock repurchase with the amount of cash saved by underinvesting. We then analyze the price impact of a cash dividend versus a share repurchase, where the price impact is defined as the abnormal return to the firm’s equity upon the actual payment of a cash dividend or the implementation of a share repurchase respectively (rather than upon the announcement of these events). Finally, we analyze the long-run returns to a firm’s equity following dividend payments and stock repurchases. Our model generates a number of testable predictions different from asymmetric information models of a firm’s choice between dividends versus stock repurchases. *College of Business, University of Texas at San Antonio, TX 78249. Phone: (210) 458 6837. Fax: (210) 458 6320. E-mail: onur.bayar@utsa.edu **Carroll School of Management, Boston College, MA 02467. Phone: (617) 552 3980. Fax: (617) 552 0431. E-mail: chemmanu@bc.edu ***School of Management, University of Kentucky, KY 40506. Phone: (859) 257 9842. Fax: (859) 257 9688. E-mail: mark.liu@uky.edu This paper is scheduled to be presented at the 2014 American Finance Association meetings in Philadelphia. For helpful comments and discussions, we thank Jeff Pontiff, David Chapman, Jonathan Reuter, Oguzhan Karakas, Alice Bonaime, Chris Clifford, Will Gerken, Kristine Hankins, Palani-Rajan Kadapakkam, Lalatendu Misra, John Wald, and seminar participants at Boston College and University of Kentucky. We alone are responsible for any errors or omissions.We analyze a firms choice between dividends and stock repurchases in an environment of heterogeneous beliefs and short sale constraints. We study a setting in which the insiders of a firm, owning a certain fraction of its equity and having a certain amount of cash to distribute to shareholders, choose between paying out cash dividends and buying back equity, as well as the scale of investment in their firms new project. Outside equity holders in the firm have heterogeneous beliefs about the probability of success of the firms project and therefore its long-run prospects; they may also disagree with firm insiders about this probability. We show that, depending on the beliefs of firm insiders versus outsiders, the firm may distribute value through cash dividends alone; through a repurchase alone; or through a combination of a cash dividend and a stock repurchase. We also show that, in many situations, it is optimal for firm insiders to underinvest in the firms positive net present value project and undertake a stock repurchase with the amount of cash saved by underinvesting. We then analyze the price impact of a cash dividend versus a share repurchase, where the price impact is defined as the abnormal return to the firms equity upon the actual payment of a cash dividend or the implementation of a share repurchase respectively (rather than upon the announcement of these events). Finally, we analyze the long-run returns to a firms equity following dividend payments and stock repurchases. Our model generates a number of testable predictions different from asymmetric information models of a firms choice between dividends versus stock repurchases.

How to Motivate Fundamental Innovation: Subsidies versus Prizes and the Role of Venture Capital

We analyze the roles of entrepreneurs, venture capitalists (VC), and the government in financing fundamental innovations, defined as those with positive social value net of development costs, but negative net present values to innovating firms. We first analyze the case where the entrepreneur, with or without VC financing, develops innovations. We then analyze government support of innovation and the governments optimal choice between subsidies and innovation prizes. We also analyze the optimal interactions between government subsidies and VC financing, and show that it is optimal for the government to channel subsidies partially through VCs, providing a rationale for government-funded VCs.

Management of Innovation, Equity Carve-Outs, and Negative Stub Values under Heterogeneous Beliefs

We develop a theory of the management of innovation and equity carve-outs under heterogeneous beliefs among investors in the equity market. We consider a setting where an employee of a firm generates an idea for a new project (“innovation”) which can be financed either by issuing equity against the future cash flows of the entire firm, i.e., both assets in place and the new project (“integration”), or by undertaking an equity carve-out of the new project (“non-integration”). The patent underlying the new project is owned by the firm. However, the employee generating the idea needs to be motivated to exert optimal effort for the project to be successful. The most important ingredient driving the firms choice between integration and non-integration is heterogeneity in beliefs among outside investors (each of whom has limited wealth to invest in the equity market) and between firm insiders and outsiders. If outsider beliefs are such that the marginal outsider financing the innovation is more optimistic about the prospects of the new project than firm insiders, and this incremental optimism of the marginal outsider over firm insiders is greater regarding the new project than about the firm’s assets in place, then the firm will implement the project under non-integration rather than integration. Two other ingredients driving the choice between integration and non-integration are the cost of motivating the employee to exert optimal effort for project implementation, and the synergy between the new project and the firms assets in place, which is eliminated under non-integration. We derive a number of testable predictions regarding a firms equilibrium choice between integration and non-integration. We also provide a rationale for the “negative stub values” documented in the equity carve-outs of certain firms (e.g., the carve-out of Palm from 3Com) and develop predictions for the magnitude of these stub values.