Entrepreneurial Learning, the IPO Decision, and the Post-IPO Drop in Firm Profitability

We develop a model of the optimal IPO decision in the presence of learning about the average profitability of a private firm. The entrepreneur trades off diversification benefits of going public against benefits of private control. Going public is optimal when the firm’s expected future profitability is sufficiently high. The model predicts that firm profitability should decline after the IPO, on average, and that this decline should be larger for firms with more volatile profitability and firms with less uncertain average profitability. These predictions are supported empirically in a sample of 7,183 IPOs in the United States between 1975 and 2004. 2 The decision to go public is one of the most important decisions made by private firms. This decision can have various motives, such as to diversify the entrepreneur’s holdings, to raise capital for investment, to exploit favorable market conditions, to facilitate acquisitions, to find the firm’s market value, to make the firm’s shares more liquid, and to make the firm more visible.1 One complicating factor in the initial public offering (IPO) decision is that th