Initially Distracted: The Influence of Boards on Agency Costs in Initial Public Offering (IPO) Firms

Abstract

While the process of pursuing an initial public offering (IPO) provides new capital with which new ventures might pursue significant opportunities, research suggests that many IPO firms decrease in value subsequent to the new offering. Using an agency perspective, we argue that the IPO process itself may not only raise direct governance costs (due to increased monitoring and bonding), but may also create a distraction for managers who need to remain focused on the strategy to effectively use a large infusion of capital from the IPO. Likewise, we argue that governance participants, especially board members, will be distracted by the work necessary to take the firm public and, as such, may not be focused on the strategic monitoring necessary for continued firm's viability. This lack of monitoring may also allow managerial opportunism to be more prevalent, especially given the large amount of capital available to managers once the IPO is completed. Accordingly, we argue that excessive governance costs (both direct and indirect) may be associated with the IPO process and subsequent IPO firm performance.

Principal Costs in Initial Public Offerings

“…This principal might leverage the board and top executives to rally the firm to engage in short‐sighted cost cutting or to aggressively accelerate revenue recognition (DuCharme et al., 2004). As top executives focus more of their efforts on improving appearances and less attention on controlling actual results, the firm is likely to suffer declines in operating performance (Dalziel et al., 2010).…”

“…Along with the benefits, however, there are significant risks that accompany the IPO process (Beatty and Zajac, 1994; Dalziel et al., 2010). By their nature, IPO firms – even with the cash infusions associated with going public – have limited resources and high levels of uncertainty (Certo, 2003; Chen et al., 2008; Lester et al., 2006).…”