Evidence on What CFOs Think About the IPO Process:
Practice, Theory, and Managerial Implications
by James C. Brau and Stanley E. Fawcett, Brigham Young University1
any privately held companies aspire to go public
M through an initial public offering (IPO). There
are two obvious benefits: First, an IPO can put a
great deal of capital into the company’s coffers.
Second, a successful IPO can generate tremendous wealth
for company insiders and pre-IPO investors. In recent years,
IPOs have raised billions of dollars for issuing firms, created
a multitude of millionaires, and generated considerable
excitement among the media.
But going public is not an easy process, nor is it without
costs. Many companies have begun the IPO process only to
withdraw the offering, often confused and frustrated by the
experience. To improve decision-making—and to mitigate
many of the uncertainties—managers need a clear picture
of the core issues involved in the IPO process. With this
as motivation, we constructed a theoretical-based survey
instrument and surveyed 336 CFOs to get their insights
into the IPO process. We studied six specific aspects of
the IPO process: (1) motives for going public; (2) the
timing of IPOs; (3) criteria for choosing an underwriter;
(4) IPO underpricing; (5) IPO signaling; and (6) reasons
to stay private. Where possible we also attempted to add
extra insight by stepping outside of the survey data to test
managerial behavior.
By surveying CFOs to obtain a real-world perspective
of the IPO process, we can also compare their beliefs and
experiences to both academic theory and the findings of
empirical research. Doing so allows us to identify the gaps
between theory and practice, and to begin to bridge those
gaps through better communication and more targeted
research. In many areas, we find harmony between CFO
beliefs and academic theory. But in several key areas, we
find that CFO perceptions diverge in significant ways from
traditional academic theory.
The main findings from the survey are summarized
below:
• The primary motive for going public is to fund growth
opportunities. More specifically, IPOs create a currency—
publicly-traded shares—that can be used to grow through
acquisitions.
1. This article draws on and uses the same dataset as our paper “Initial Public Offer-
ings: An Analysis of Theory and Practice,” Journal of Finance, Vol. 61 (2006).
Journal of Applied Corporate Finance • Volume 18 Number 3
• CFOs strongly base the timing of their IPOs on
overall stock market conditions, while paying least attention
to IPO market conditions. Yet empirical evidence shows
that IPO market conditions, particularly within industry,
are strongly related to timing.
• CFOs choose underwriters based on their overall
reputation and the underwriter’s industry expertise. Surpris-
ingly, issuers were not very concerned about the underwriter
fee structure, perhaps indicating general acceptance of the
typical 7% spread.
• CFOs view underpricing mainly as a means of
compensating investors for taking on the risk of the IPO.
They typically do not believe that underpricing is a result
of practices such as “spinning” or “flipping” that are often
criticized as being detrimental to issuers.
• The two strongest perceived positive signals for issuer
quality are a history of strong earnings and a top investment
bank. The strongest negative signal is the sale of insider
shares in the IPO.
• The primary reason cited for staying private is a desire
to maintain decision-making control.
The IPO process is time-consuming, expensive,
and fraught with uncertainty. Getting it wrong can set a
company back a year or more, highlighting the importance
of being well-informed and prepared. The survey results
suggest that most CFOs have a good understanding of the
issues, and the divergence between the findings and the
theory may be a matter of semantics more than anything
else. Nonetheless, we offer some recommendations on key
points that CFOs need to consider as they think about and
actually undertake an IPO.
The Survey
Our survey targeted three distinct groups: (1) CFOs of
companies that had successfully completed an IPO from
January 2000 through December 2002; (2) CFOs of
companies that had filed a prospectus to go public in the
same time period, but then subsequently withdrew the
offering; and (3) CFOs of private firms that were large
enough to go public in the same time period, but chose not
A Morgan Stanley Publication • Summer 2006 107
Figure 1 Survey Evidence on the Motivations for Going Public
 
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4OENHANCETHEREPUTATIONOFOURCOMPANY
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4OALLOWVENTURECAPITALISTS6#S TOCASHOUT
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to. A total of 336 CFOs responded to the survey, with 87,
37, and 212 responses for the three aforementioned groups,
respectively. A detailed description of the survey method is
provided in the appendix.
Motives for Going Public
Scarcity of data has limited empirical investigation into
perhaps the most fundamental question about the IPO
process: Why do companies choose to go public? Several
theories have been advanced in the academic literature.
Most such theories begin with the assumption that markets
are efficient and that managers aim to maximize firm value.
Given such assumptions, the principal reason for companies
to go public is to raise capital to fund investment opportu-
nities — and to raise that capital in a way that minimizes
the company’s weighted average cost of capital.2 A second
motive, not necessarily consistent with either market effi-
ciency or value-maximizing behavior by the issuers, is to
allow insiders to cash out, presumably at the highest price
possible, and perhaps diversify their holdings.
2. See J. Scott, “A Theory of Optimal Capital Structure,” Bell Journal of Economics,
Vol. 7 (1976) and F. Modigliani and M. Miller, “Corporate Income Taxes and the Cost of
Capital: A Correction,” American Economic Review, Vol. 53 (1963). An alternative theory,
known as the pecking order theory, suggests that insiders conduct IPOs to gain access
to capital when other, cheaper sources of capital (such as internal equity and debt) have
been exhausted. See S. Myers, “The Capital Structure Puzzle,” Journal of Finance, Vol. 3,
(1984) and S. Myers and N. Majluf, “Corporate Financing and Investment Decisions when
Firms have Information that Investors do not Have,” Journal of Financial Economics, Vol.
13 (1984).
108 Journal of Applied Corporate Finance • Volume 18 Number 3
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Using variations of these two basic motives, and of the
assumptions underlying them, we were able to come up with
ten different possible motives for going public. We then
asked CFOs to evaluate the importance of each of these ten
motives. The CFO responses, as summarized in Figure 1,
yielded two surprises. First is the relatively low importance
CFOs appear to place on using an IPO to minimize the cost
of capital, which ranked only sixth among reasons for going
public. Second, two related questions received the weakest
CFO endorsement: “our company has run out of private
equity” (28% agree) and “debt is becoming too expen-
sive” (14% agree). Also contrary to the standard academic
“trade-off ” theory of optimal capital structure, neither cost-
of-capital nor capital availability arguments were explicitly
recognized as the main drivers of the going-public decision.
Nevertheless, the motive that was cited by the highest
percentage of CFOs (nearly 60%)—the creation of public
shares for use in future acquisitions—can be readily inter-
preted as a means of raising equity capital to fund growth
opportunities.3 Having publicly traded stock enables compa-
3. Funding acquisitions is consistent with theory insofar as theory says IPOs provide
low-cost equity for funding growth. See M. Barclay and C. Smith, “The Capital Structure
Puzzle: Another Look at the Evidence,” Journal of Applied Corporate Finance, Vol. 12
(1999), who showed that equity is an appropriate vehicle for companies with growth
opportunities. Many IPO firms are companies with growth strategies that want equity,
especially for stock swap mergers.
A Morgan Stanley Publication • Summer 2006
Figure 2 Survey Evidence on the Timing of IPOs
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DAYSTOCKPERFORMANCEOFRECENT)0/3 
nies to participate in the M&A market by providing them
with a currency for acquiring other firms.4 What’s more,
the only other rationale to receive majority support from
CFOs—the opportunity to establish a market price—can
also be viewed as the first step in the acquisition process.5
To further explore acquisition motives, we stepped
outside of the survey data and investigated M&A activity for
our sample of IPOs, comparing it to a benchmark portfolio
of already public companies.6 We found that, after going
public, our 87 IPO firms acquired a total of 141 companies,
while only 18 of the IPO firms became targets. Further-
more, the 141 acquisitions by our IPO firms compared to
only 96 acquisitions by pair-matched non-IPO benchmark
companies, suggesting that IPOs are designed at least in
part to facilitate acquisition activity. Thus, going public
appears to be a critical step in acquisition-based growth
strategies for many companies.
An IPO is one way for the firm insiders to achieve their
goals of either cashing out or raising capital, but another
way is to be acquired. Depending on the circumstances,
this may be a more attractive option than an IPO, but at
a minimum the two should be considered simultaneously.
Although an academic study (involving one of the current
authors) has shown that insiders in a takeover do not appear
to receive as high a payoff as IPO insiders (in comparable
cases), takeovers will decrease the risk assumed by the
exiting insiders.7 In a follow-on study, the same authors also
showed that if insiders choose a dual-track strategy (filing
for an IPO at the same time as courting acquirers), the
4. This finding is consistent with J. Brau, B. Francis, and N. Kohers, “The Choice of IPO
versus Takeover: Empirical Evidence,” Journal of Business, Vol. 76 (2003).
5. See A. Mello and J. Parsons, “Going Public and the Ownership Structure of the Firm,”
Journal of Financial Economics, Vol. 49 (1998) who argue, “Viewing the IPO as a step in a
more complete process of selling the firm is the result of considering the inherent asym-
metry of investors together with the strategic behavior on the part of the seller.”
6. The data for this follow-on analysis was obtained from SDC’s M&A database through
the end of July 2004.
Journal of Applied Corporate Finance • Volume 18 Number 3
     



takeover discount can be sharply lowered.8 Managers intent
on raising additional capital should also consider private
placements of debt or equity, which may be less costly than
an IPO.
One final observation: companies that have never
attempted an IPO view the corporate motives for going
public differently from their counterparts. Specifically, the
motive for going public most cited by “not-tried” CFOs is
the opportunity for principals to cash out and diversify their
holdings (a motive that ranked only sixth and eighth for
successful and withdrawn IPOs, respectively). Also notable,
the CFOs of not-tried companies claim to be less concerned
about their company’s perceived market value or reputation
than CFOs whose firms had either contemplated or done
an IPO.
The Timing of IPOs
A second important question is the timing of an IPO.
Here there are two main explanations, again with multiple
variations on each. The life-cycle theory argues that, as a
company grows, at some point it is more economical for it
to obtain external equity financing through an IPO. The
timing decision is thus a natural consequence of a compa-
ny’s maturation. According to this theory, companies go
public when they reach a point in their life cycle where they
need an IPO to raise equity to fund growth and create a
public and liquid market for firm ownership.
The second line of reasoning emphasizes market timing.
The argument here is that insiders use their superior infor-
7. See J. Brau, B. Francis, and N. Kohers, “The Choice of IPO versus Takeover: Empiri-
cal Evidence,” Journal of Business, Vol. 76 (2003) for a complete analysis of IPO versus
takeover. Also see A. Poulsen, and M. Stegemoller, “Moving from Private to Public Owner-
ship: Selling out to Public Firms vs. Initial Public Offerings,” University of Georgia, Working
paper (2005), for a more recent study of the IPO versus takeover decision.
8. See J. Brau and N. Kohers, “Dual-Track versus Single-Track Sell-Outs: An Empiri-
cal Analysis of Competing Harvest Strategies,” Brigham Young University, Working paper
(2006).
A Morgan Stanley Publication • Summer 2006 109
mation about the firm’s prospects to exploit “windows of
opportunity” by issuing shares that, if not overvalued, are at
least sufficiently fully valued to avoid dilution of the exist-
ing shareholders’ claims.9
How insiders define such windows is a source of debate.
Some academics suggest they look at general market condi-
tions as the gauge. Others argue that industry conditions are
the driving factors. Still others claim it is the momentum of
the IPO market that matters. Through our questions, we
attempt to disentangle the main driver—overall market,
industry, or IPO market—of issuing windows.10
The CFOs were asked which factors most influenced
the timing of their (possible) IPO. As summarized in
Figure 2, the CFO responses indicate that issuers are clearly
opportunistic in timing their IPOs. First of all, while 66%
of CFOs said they were raising capital to fund continued
growth, 83% indicated that overall stock market conditions
were the primary determinant in timing their IPOs. These
insiders thus appear to target windows of opportunity to
maximize the share value and the amount of money that
can be raised through the IPO. And the CFOs of venture
capital-backed IPOs were particularly intent on exploiting
temporary windows of opportunity.
Moreover, 83% of CFOs said they defined these windows
in terms of overall stock market conditions, while 70% also
said that general industry conditions play a role in their
timing decisions. By contrast, indicators closely related to
IPO market conditions were said to receive very little CFO
attention. This was true of the CFOs of all but the smallest
firms, which claim to rely more heavily on other “quality”
firms going public as a reliable guide to good timing.
The CFOs’ response that IPO market conditions are
largely irrelevant is at odds with empirical research, which
generally finds that IPO market factors such as under-
pricing, especially within an industry, are a significant
determinant of the timing decision. An explanation for this
contradictory evidence may be that while CFOs focus on
broad market conditions, their investment bankers follow
the IPO market closely, and the underwriters have a signifi-
cant effect on the final timing decision. Moreover, CFOs
might be wise to look closely at IPO market conditions
because they provide a good indication of the valuation
investors will likely assign their company. One study found
that selecting comparable multiples such as P/Es or price-
9. See T. Loughran and J. Ritter, “The New Issues Puzzle,” Journal of Finance, Vol. 50
(1995) for a discussion and evidence of windows of opportunity.
10. See D. Lucas and R. McDonald, “Equity Issues and Stock Price Dynamics,”
Journal of Finance, Vol. 45 (1990); J. Ritter and I. Welch, “A Review of IPO Activity, Pric-
ing, and Allocations,” Journal of Finance, Vol. 57 (2002); M. Pagano, F. Panetta, and L.
Zingales, “Why Do Companies Go Public? An Empirical Analysis,” Journal of Finance,
Vol. 53 (1998); M. Lowery, “Why Does IPO Volume Fluctuate So Much?,” Journal of
Financial Economics Vol. 67 (2002); M. Lowery and W. Schwert, “IPO Market Cycles:
Bubbles or Sequential Learning?,” Journal of Finance Vol. 57 (2002); and H. Choe, R.
Masulis, and V. Nanda, “Common Stock Offerings Across the Business Cycle: Theory
and Evidence,” Journal of Empirical Finance, Vol. 1 (1993).
110 Journal of Applied Corporate Finance • Volume 18 Number 3
to-sales ratios from recent IPOs to determine a value for the
current IPO leads to more accurate pricing than the use of
industry-based comparable multiples.11
To the extent the shares issued in an IPO prove to be
overpriced, timing the issue to exploit windows of oppor-
tunity clearly benefits insiders and pre-IPO investors at
the cost of new shareholders. Although a matter of debate,
many researchers believe that IPOs have underperformed
on a risk-adjusted basis over the long run in many countries,
including the U.S.12 But this, of course, begs the question:
If successful market timing by issuers implies low returns,
on average, for investors who buy early in the secondary
market, why do outside investors continue to be hungry for
IPOs? We argue that IPO investors are seeking not so much
average returns as the possibility of “home runs.” A line of
academic research provides both a theoretical argument
and some supporting evidence that investors often willingly
accept lower average pay-offs on securities that offer higher
probabilities of a big pay-off.13
Selecting an Underwriter
Choosing the right underwriter can greatly enhance the
going public process. The underwriter performs a variety of
roles, perhaps the most important of which is to generate
market visibility and interest in the offering. To help make
this marketing effort successful, the underwriter coaches
the company and assists in the preparation of the offering
prospectus so it meets SEC requirements and looks attrac-
tive to potential investors. During the marketing stage,
the company’s officers go on “roadshows” to pitch the
IPO. Underwriters provide vital guidance throughout this
process and “build the book” of orders by gauging the level
of interest of major institutional investors. After the IPO,
the underwriter usually provides liquidity, often as a market
maker, to maintain the stock’s strength and build momen-
tum for the future.
We asked the CFOs to indicate “How important are/
were the following criteria in selecting a lead IPO under-
writer?”14 Figure 3 reports their responses. Issues that affect
the underwriter’s principal intermediary role—the ability to
provide the expertise needed to successfully complete the
IPO—dominate the selection process. CFOs are primar-
ily interested in the underwriter’s overall reputation (91%
agree), industry expertise (88%), and research capability and
11. See. M. Kim and J. Ritter, “Valuing IPOs,” Journal of Financial Economics, Vol.
53 (1999).
12. See T. Loughran, J. Ritter, and K. Rydqvist, “Initial Public Offerings: International
Insights,” Pacific-Basic Finance Journal, Vol. 2 (1994) and T. Loughran and J. Ritter, “The
New Issues Puzzle,” Journal of Finance, Vol. 50 (1995).
13. In statistical language, IPO investors seem to have a preference for right-skewed
distributions of returns. For a discussion of skewness preference among investors,
see T. Mitton and K. Vorkink, “Equilibrium Underdiversification and the Preference for
Skewness,” Review of Financial Studies, forthcoming.
14. We obtain this question from L. Krigman, W. Shaw, and K. Womack, “Why do
Firms Switch Underwriters?”, Journal of Financial Economics, Vol. 60 (2001).
A Morgan Stanley Publication • Summer 2006
Figure 3 Survey Evidence on Reasons for Selecting an Underwriter

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quality (83%). Two other criteria received majority support:
the institutional client base (57%) and the market-making
and trading-desk capabilities of the underwriter (56%).
Other criteria such as pricing and valuation promises, fee
structure, the underwriter’s retail client base, and the avail-
ability of non-equity-related services received much less
CFO attention.
What do these findings imply? First, the importance of
industry expertise highlights a role for boutique underwrit-
ers who specialize in certain sectors or industries. Second,
CFOs appear to care much more about institutional inves-
tors than they do about retail investors, and to believe that
if a capable and reputable underwriter is selected, the stock
valuation and pricing will be reasonable. Third, CFOs
appear to trust the work of highly reputable investment
banks and are willing to pay for their services. For many
CFOs, reputation appears to be a surrogate for an exten-
sive selection process, reducing the need to conduct costly
analysis of an underwriter’s capability.
Our findings here also suggest that the fee structure
is not a major factor in choosing an underwriter and our
subsequent finding (reported in Figure 6) that CFOs do
not consider the costs of paying prestigious underwriters
15. See A. Sherman, “Global Trends in IPO Methods: Book Building versus Auctions
With Endogenous Entry,” Journal of Financial Economics, (forthcoming).
16. See R. Ibbotson, J. Sindelar, and J. Ritter “The Market’s Problems with the Pric-
ing of Initial Public Offerings,” Journal of Applied Corporate Finance, Vol. 7 (1994) for a
discussion of three IPO phenomena, to include underpricing.
Journal of Applied Corporate Finance • Volume 18 Number 3
as a barrier to going public are also of interest. The CFO
responses suggest that they feel they are receiving a service
commensurate to the fees paid. A recent academic study
suggests that, by using the bookbuilding method, under-
writers “(1) reduce risk for both issuers and investors and (2)
control spending on information acquisition, thereby limit-
ing either underpricing or aftermarket volatility.”15
One qualification does surface in the subsample tests.
Although not-tried CFOs also pay close attention to overall
underwriter reputation, they are somewhat skeptical of
the underwriting process. To overcome this skepticism by
potential clients, investment banks may consider making
the IPO process more transparent.
CFO Perceptions of IPO Underpricing
IPO underpricing occurs when the offer price is lower than
the first-day market closing price.16 The average underpric-
ing for U.S. IPOs during the period 1960-2004 was 18%,
which means that primary market investors who received
an IPO allocation earned an average immediate one-day
return of 18%.17 The widespread existence of underpricing
suggests that money is consistently “left on the table” by the
issuing companies.18 If the goal is to maximize the amount
17. The median return over this period was 13.5%. For the time series of data on aver-
age monthly underpricing from 1960 through 2004, see Jay Ritter’s website at: http://
bear.cba.ufl.edu/ritter/index.html.
18. See J. Ritter, “The Costs of Going Public,” Journal of Financial Economics, Vol.18
(1987) for a discussion of underpricing as a cost to issuers.
A Morgan Stanley Publication • Summer 2006 111
Figure 4 CFO Perceptions of IPO Underpricing
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of capital that is raised through an IPO, the obvious ques-
tion is, Why does underpricing exist? We also attempted to
determine the extent to which CFOs’ expectations about
underpricing are realistic.
Focusing first on expectations, we asked CFOs what
level of underpricing they expected prior to the offer. The
median level of expected underpricing was 10.0%. This
expectation compared to an actual median of 13.5%. Thus,
with the exception of a few outliers, CFOs appear to be
well-informed about the level of underpricing.
Academics have put forth a great deal of effort to explain
why underpricing exists. Many of the proposed theories argue
that underpricing is due to asymmetric information—the
possibility that managers are better informed than investors,
or that some investor groups are more informed than others.
One much cited theory says that, when relatively uninformed
investors (say, “retail” investors) are bidding against sophis-
ticated well-informed investors (“institutions”), the former
face a potential “winner’s curse”—the possibility that they
will receive allocations of mainly just overpriced IPOs.
According to this theory, underpricing is necessary to induce
these uninformed investors to bid, given their vulnerability
to overpricing.19 Another information-based theory argues
that sophisticated investors must be compensated through
19. See K. Rock, “Why New Issues are Underpriced,” Journal of Financial Economics,
Vol. 15 (1986).
20. See L. Benveniste and P. Spindt, “How Investment Bankers Determine the Offer
Price and Allocation of New Issues,” Journal of Financial Economics, Vol. 24 (1989) and
L. Benveniste and W. Wilhelm, “A Comparative Analysis of IPO Proceeds Under Alternative
Regulatory Environments,” Journal of Financial Economics, Vol. 28 (1990).
112 Journal of Applied Corporate Finance • Volume 18 Number 3
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underpricing for revealing their true demand for the issue
during the bookbuilding process, a necessary step for build-
ing demand in the offering.20 Other underpricing theories
have been advanced that rely on different assumptions, some
of which form the basis of questions we posed to CFOs.
Figure 4 reports CFO responses when asked why under-
pricing exists. Among the numerous theories the CFOs were
asked to evaluate, there was one clear favorite—that under-
pricing compensates investors for taking on the risk of the
IPO (60% agree). The supporting logic for this choice is as
follows: Because the initial secondary market price is uncer-
tain when the primary market price is set, IPO investors bear
risk that would otherwise be borne by issuers or their under-
writers. In this sense, primary market investors are effectively
insuring issuers against the possibility of an adverse second-
ary market reception. Underpricing is the premium charged
by investors for providing such insurance.
In sum, CFOs attributed most of the underpricing to
market uncertainty and the lack of perfect information. At
the same time, however, a large minority (42%) expressed
some suspicion that underwriters seek to opportunistically
profit from underpricing by currying favor with institutional
investors. Even so, the low scores for “flipping” and “spinning”
suggest that CFOs place a great deal of trust in their under-
21. Flipping occurs when investors who received an allocation in the offering immedi-
ately sell the shares in the secondary market. Spinning is the practice of allocating shares
in “hot” offerings to senior executives in other companies in order to curry favor for future
investment banking business.
A Morgan Stanley Publication • Summer 2006
Figure 5 Survey Evidence of IPO Signaling
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writers and the underwriting process.21 The bottom line may
be that most executives are not greatly troubled by underpric-
ing and accept it as a cost of going public.
On the other hand, the emergence of a few high-profile
firms choosing to price their IPOs through Dutch auctions
instead of traditional bookbuilding may indicate a degree
of issuer dissatisfaction with underpricing. For example,
Google and Morningstar both completed successful IPOs
using the auction method. Although IPO auctions have
received more attention of late, they have been relatively
rare events.22 For example, WR Hambrecht, a firm that
specializes in bringing firms to market through the Dutch
auction method, has managed only 14 IPOs since its start
in 1999.23
It is interesting that according to SDC data, although
Google used an auction system to price its IPO, it still
experienced 18% underpricing (measured from offer price
of $85 to $100.33 on the day after the offer). For the full
11 IPOs for which WR Hambrecht has acted as the single
lead underwriter since its creation in 1999, the auction
system has averaged underpricing of 35%.24 But this 35%
is somewhat misleading since when we remove the effect
22. Auctions have been tried more extensively in countries other than the U.S., but
their track record of success is very poor. Most countries that experimented with auctions
have since abandoned them, with few using them at all anymore. For a discussion of why
that’s the case, see Ravi Jagannathan and Ann Sherman, “Reforming the Bookbuilding
Process for IPOs,” Journal of Applied Corporate Finance Vol. 17 (2005), pp. 67-72.
23. See S. Syre, “The IPO Path Less Taken,” Boston Globe (Sept 1, 2005) for a discus-
sion of IPO auctions. Our number of 14 IPOs is from the SDC database.
24. SDC indicates the 11 IPOs are: Ravenswood Winery, Salon.com, Andover.net, No-
gatech, Peet’s Coffee & Tea, Briazz, Overstock.com, RedEnvelope, Genitope, New River
Pharmaceuticals, and Morningstar. The three firms that have been co-led by WR Hambre-
Journal of Applied Corporate Finance • Volume 18 Number 3
      









of a single outlier (Andover.net, which experienced 330%
underpricing), the average underpricing of the remain-
ing 10 firms underwritten by Hambrecht drops to 5.8%.
However, due to the small number of U.S. IPO auctions to
date, it is not possible to make any definitive comparisons
between bookbuilding and auctions.25
One thing CFOs can do to minimize the underpricing is
to be more aggressive in negotiating the IPO offer price with
the underwriter. A recent study found that approximately
75% of IPOs between 1981 and 2000 had exact integer
offer prices (round dollar).26 These IPOs experienced on
average 25% underpricing, whereas the non-integer priced
IPOs (say, $9.50) experienced only 8% underpricing.
Formal tests support the assertion that tougher negotiation
by the issuing firms (as indicated by the non-integer offer
prices) reduced the underpricing of their issues.
IPO Signaling
Outside investors typically know little about a company
when it begins the IPO process. So although the SEC
requires a detailed offering prospectus, company insiders
possess far more information about the firm than these
cht are Sunset Financial Resources (with JP Morgan), Bofl Holding (with Seidler) and Hemo-
Sense (with Lazard Capital Markets). We use SDC offer price and first day close data.
25. Another difficulty with making a straight comparison between bookbuilding and
auction underpricing is that it does not control for the various factors that affect underpric-
ing, such as firm and offer size, risk, underwriter reputation, etc.
26. See D. Bradley, J. Cooney, B. Jordan, and A. Singh, “Negotiation and the IPO Offer
Price: A Comparison of Integer vs. Non-Integer IPOs,” Journal of Financial and Quantitative
Analysis, Vol. 39 (2004).
A Morgan Stanley Publication • Summer 2006 113
Figure 6 Survey Evidence on Reasons Why Some Firms Choose to Stay Private
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investors. Recognizing that insiders may be timing the issue
to sell overpriced stock, outside investors look for signals
of firm quality. The idea behind signaling theory is that
“good” firms take certain actions that “bad” firms are either
unwilling or can’t afford to take.
One example of an attempt to signal quality is the use
of lockups. Insiders in a high-quality issue may agree not to
sell their shares for a long period of time after the IPO, confi-
dent that strong analyst ratings and good future earnings
will propel the stock price higher. It’s true that insiders
in low-quality firms could try to mimic the strategy of
a long lockup to garner a higher offer price, and effectively
sell overpriced shares. But that would mean running the
risk that, before the lockup expires, outside investors learn
through analyst reports and earnings announcements
that the firm is not as “good” as advertised, and the share
price falls to its fair value. Insiders who knowingly hold
shares in overvalued companies are unlikely to agree to a
long lockup period.27
What actions do CFOs perceive as reliable signals? We
asked the CFOs to evaluate nine possible signals identi-
fied in the theoretical literature. As shown in Figure 5, the
27. For a complete discussion and theoretical model with empirical tests on this ex-
ample of IPO lockups serving as signals, see J. Brau, V. Lambson, and G. McQueen,
“Lockups Revisited,” Journal of Financial and Quantitative Analysis, Vol. 40 (2005).
28. See S. Teoh, I. Welch, and T. Wong, “Earnings Management and the Long-Run Per-
formance of Initial Public Offerings,” Journal of Finance, Vol. 53 (1998) for a discussion of
window-dressed IPO prospectuses and their impact on subsequent stock performance.
114 Journal of Applied Corporate Finance • Volume 18 Number 3
    








most frequently cited signal of firm quality is a track record
of strong historical earnings (91% agree). Past success is
viewed as an indication of future returns and is a trait that
cannot be easily imitated by lower quality firms. But there is
a downside: the possibility that window dressing can make
the numbers appear better than they really are.28
The “certification” provided by an association with
reputable financial intermediaries is also widely viewed as a
very strong positive signal. A prestigious investment banker
is the most positive signal (89% agree), followed by the
use of a Big 4 accounting firm (74%) and the backing of a
venture capital firm (40%).
Finally, commitment to a long lockup (78%) and a
large first-day stock price jump (73%) are also viewed as
positive signals. This last observation—that leaving a large
amount of money on the table communicates a strong
positive signal—requires some comment. Evidently, CFOs
are willing to bear the cost of underpricing because they
feel it functions as valuable advertising. Although this may
seem inefficient, it is consistent with the argument that
high-quality firms can afford to sacrifice some value in the
form of underpricing, whereas low-quality firms cannot.29
29. See F. Allen and G. Faulhaber, “Signaling by Underpricing in the IPO Market,” Jour-
nal of Financial Economics, Vol. 23 (1989); T. Chemmanur, “The Pricing of Initial Public
Offers: A Dynamic Model with Information Production,” Journal of Finance, Vol. 48 (1993);
and I. Welch, “Seasoned Offerings, Imitation Costs, and the Underpricing of Initial Public
Offerings,” Journal of Finance, Vol. 44 (1989).
A Morgan Stanley Publication • Summer 2006
Yet several empirical studies have cast doubt on the efficacy
of underpricing as a positive signal by showing that compa-
nies with greater underpricing are also less likely to return
to the market to raise more equity capital and that firms
with lower underpricing enjoy higher earnings and pay
higher dividends.30 Although the CFOs generally viewed
a large first-day stock price jump as a positive signal, only
23% of them (see Figure 4) felt that a legitimate reason
for underpricing was “to increase publicity on the opening
day.” Thus, although CFOs appear to feel underpricing is
a positive signal, they don’t appear to assign much value to
the signal.
CFOs view three corporate actions sometimes associ-
ated with IPOs as negative signals to investors: (1) selling
insider shares in the IPO (80% agree), (2) selling a large
portion of the firm in the IPO (44%), and (3) issuing units
(43%). The first two are perceived negatively because they
raise the suspicion that insiders are rushing to cash out
overvalued shares.31 Of course, IPO insiders may still believe
the shares are fairly (or even under) valued and may simply
desire diversification. But if so, they should take efforts to
communicate to potential investors why they need such
diversification. Issuing units—offerings in which warrants
are attached to the shares of stock at issuance—may signal
that insiders believe that shares alone are not enough to
successfully float the offer.32
Why do Some Companies Choose to
Stay Private?
While the prospect of a successful IPO has captured the
imagination of many managers, some companies simply
are not interested in going public. We asked CFOs why
not. Based on their responses, which are shown in Figure
6, company insiders choose to remain private for a variety
of reasons. Not surprisingly, of all the questions posed in
our survey, this one resulted in the greatest differences of
opinion between the three subsamples (withdrawn IPOs,
successful IPOs, and not-tried IPOs).
The most cited reason in the complete sample to remain
private is to maintain decision-making control (56% agree).33
Among the CFOs, IPOs are believed to dilute ownership,
giving insiders a smaller piece of the pie and perhaps reduc-
ing their control over important investment and operating
decisions. As expected, such control issues were by far the
most important concern for CFOs of companies that have
30. For example, see R. Michaely and W. Shaw, “The Pricing of Initial Public Offer-
ings: Tests of Adverse-Selection and Signaling Theories,” Review of Financial Studies,
Vol. 7 (1994); J. Garfinkel, “IPO Underpricing, Insider Selling and Subsequent Equity Of-
ferings: Is Underpricing a Signal of Quality?” Financial Management, Vol. 22 (1993); and
N. Jegadeesh, M. Weinstein, and I. Welch, “An Empirical Investigation of IPO Returns and
Subsequent Equity Offerings,” Journal of Financial Economics, Vol. 34 (1993).
31. These first two findings are consistent with the theoretical model of H. Leland
and D. Pyle, “Information Asymmetries, Financial Structure, and Financial Intermediation,”
Journal of Finance, Vol. 32 (1977).
Journal of Applied Corporate Finance • Volume 18 Number 3
never attempted to go public. For now, these CFOs were
satisfied that they have enough capital to finance the firm’s
investments and operations and so perceived little value in
going public.
In the minds of CFOs, the second most impor-
tant reason not to go public is outside the control of the
company—unfavorable market or industry conditions
(48% agree). As we’ve already seen, CFOs are opportunis-
tic, wanting to take their companies public when an IPO
will generate as much capital and wealth as possible. CFOs
from the withdrawn sample were extremely sensitive to bad
market/industry conditions (with 95% agreement). That
such concerns were far more important than control issues
is not surprising, since such firms had already at one point
decided to go public.
The CFOs from the companies that successfully
completed the IPO process generally agree with their
counterparts that control and timing were the most impor-
tant issues considered as they approached the IPO process.
The only other issue these CFOs considered truly important
was concern about disclosing information to competitors.
Most CFOs do not view the expenses of an IPO as a deter-
rent (only 27% cited as “important”). And Sarbanes-Oxley,
despite the hype in the media, received very low scores from
all three groups of CFOs (only 19%).
Conclusion
Surveying CFOs about their views on the IPO process
provides a window into their perceptions and understand-
ing. It enables us to observe where perception might deviate
from reality, and how this might lead to less than optimal
decisions during the IPO process. When that appears to be
the case, we have tried to offer specific recommendations of
what can and should be done differently.
Overall, most CFOs understood the basic issues involved
in the IPO process and were comfortable with it, but there
were specific details that they were not familiar with and
interpretations at odds with available empirical evidence.
For example, IPO market conditions have a strong influ-
ence on both timing and valuation, yet most CFOs look
only at market or industry-wide performance. As a result,
they may be ignoring useful information that could lead to
a more successful offering.
A desire to pursue acquisitions to spur growth—facili-
tated by increased cash and a liquid stock—was the number
32. See P. Schultz, “Unit Initial Public Offerings: A Form of Staged Financing,” Journal
of Financial Economics, Vol. 34 (1993).
33. Not-tried CFOs strongly ranked decision-making control as their top reason. Suc-
cessful CFOs ranked decision-making as their third choice, behind bad market/industry
conditions and disclosing information to competitors. Withdrawn CFOs ranked decision-
making fifth, behind bad market/industry conditions, low price of stock, already have
enough capital, and officer liability.
A Morgan Stanley Publication • Summer 2006 115
one reason cited for going public. But CFOs should also
consider a dual-track process of filing for an IPO and court-
ing acquirers; it raises the attainable value in a takeover and
provides a ready alternative if the IPO market closes.
Underpricing was a cost of going public that the CFOs
readily accepted without much complaint. Yet they may
have the ability to reduce the amount of underpricing and
so raise the offer price. They can negotiate harder for a
higher offer price, even if it’s only for 50 cents, and avoid
any actions, such as insider selling or too large an offering,
that convey a negative signal. Finally, the positive signaling
value of a large initial return may be quite limited, and thus
more costly than it’s worth.
jim brau is an Associate Professor of Finance and the Goldman
Sachs Faculty Fellow at BYU.
stan fawcett is the Donald L. Staheli Professor of Business
Management at BYU.
Appendix: Survey Methods and Data
To find out how CFOs view the IPO process, we conducted
a mail survey using the Dillman Total Design Method,
which has become a standard for conducting rigorous
surveys.34 After conducting a thorough review of the IPO
literature, we carefully crafted questions to address theo-
retical and process issues. We pre-tested the survey with
several key informants who are well-versed in the going-
public process. Their feedback was used to improve the
survey.
As we built the survey, we constructed three separate
mailing lists. We searched Thomson Financial’s SDC New
Issues Database to identify companies that had successfully
completed an IPO from January 2000 through December
2002. We also searched SDC for firms that filed a prospectus
to go public, but then subsequently withdrew the offering.
Our third sample consisted of private firms that were large
enough to go public, but chose not to conduct an IPO. This
group of companies was compiled from Dun and Bradstreet
and Reference USA and included the largest 1,500 non-
financial privately held firms based on 2002 revenues. Our
final mailing lists consisted of 340 successful IPOs, 179
withdrawn IPOs, and 1,266 non-tried IPO firms for which
we could find accurate mailing information.
Through three rounds of mailings we received completed
surveys from 336 CFOs (212 not-tried (17% response rate),
87 successfully completed (26% response rate), and 37
withdrawn (21% response rate)). The aggregate response
rate of 19% is considered excellent in financial research.
Comparing the respondents to the sampling frame, we
determined that the sample was representative of the overall
population. The basic demographics for the sample are
reported in Table 1.
One concern with our sample may be the sample
period—2000-2002 was mostly a bear market. This

Table 1 Sample Descriptive Statistics*

Variable Mean Median Minimum Maximum

Revenues ($ millions) 373 99 0 153,020

Firm Age (years) 25 15 0 153
High Technology (%) 19
Venture Capital Backed IPO (%) 58
Initial Return IPO > 10% (%) 54

Major SIC
Industry description Group Frequency Percentage

Agriculture, Forestry, and Fishing 01-09 3 0.9

Mining 10-14 5 1.5
Construction 15-17 22 6.6
Manufacturing 20-39 116 34.9
Transportation, Communications,
Electric, Gas, and Sanitary Services 40-49 27 8.1
Wholesale Trade 50-51 57 17.2
Retail Trade 52-59 29 8.7
Services 70-89 73 22.0
*There are no finance (SIC = 60-67) or public administration (SIC = 91-97) firms in our sample.
Four SIC codes could not be determined, reducing the industry statistics to a sample of 332.

34. See A. Dillman, Mail and Telephone Surveys: The Total Design Method (1978, New
York: John Wiley & Sons) for a thorough discussion on survey methods.

116 Journal of Applied Corporate Finance • Volume 18 Number 3 A Morgan Stanley Publication • Summer 2006
market condition begs the question: Can the results of our
study be generalized to other time periods? In an attempt
to determine if our sample is robust to other time periods,
we asked the underwriter selection question directly from
a previous Journal of Financial Economics study that dealt
with why firms switch underwriters.35 Our data from
2000-2002 held close correlation to the earlier study
replies which were from 1993-1995, suggesting that CFO
sentiment (at least for this one issue) is robust between
35. See L. Krigman, W. Shaw, and K. Womack, “Why do Firms Switch Underwriters?,”
Journal of Financial Economics, Vol. 60 (2001).
Journal of Applied Corporate Finance • Volume 18 Number 3
the two periods. Because our study is unique, it is not
possible to compare the other questions to extant survey
responses. Whereas our results may not be 100% repli-
cable in different market conditions, we do feel that the
majority of the results can be generalized to other time
periods. For example, the CFO opportunistic mindset of
timing the offer should not change across time. Similarly,
issuing to facilitate M&A should be just as valid in the
current market as in the paper’s sample period.
A Morgan Stanley Publication • Summer 2006 117