JOURNAL OF ECONOMICSAND FINANCE 9 Volume 31 9 Number 3 9 Fall 2007 359

WHY DO COMPANIES CHOOSE TO GO IPOS?

NEW RESULTS USING DATA FROM TAIWAN

By Yang-Pin Shen and Peihwang Wei"

Abstract
We examine the determinants of lPOs in Taiwan for the period 1989 to 2000. The regulations
in Taiwan permit us to identify f r m s that met IPO requirements but chose not to go public,
allowing for comparisons of firms that choose IPOs and those do not. We find strong evidence that
IPOs are not motivated by financing need, that larger and profitable firms are more likely to list
equity, and that venture capital provides certification to firm credibility. Other findings provide
support for information asymmetry, listing costs, liquidity, owners' diversification desire, timing,
and facilitation of M&As as factors influencing IPO decisions. (JEL G32, G15, G24)

Introduction

Research in initial public offerings (IPOs) is vast and has been growing at a faster pace in
recent years (Varshney and Robinson, 2004). However, the research has been mostly concentrated
on post-IPO performances and markets. Moreover, as Ritter and Welch (2002) state "For the most
part, formal theories of IPO issuing activity are difficult to test. This is because researchers usually
only observe the set of firms actually going public. They do not observe how many private firms
could have gone public." One notable exception is Pagano, Panetta and Zingales (1998, hereinafter
PPZ) that studies IPOs in Italy. ~ Their study indicates that IPOs are relatively infrequent events in
Italy--only 69 firms conducted IPOs in their sample period of 1982 to 1992, which is just a
fraction of over 10,000 public companies in that country. Moreover, the breath of the IPO market
is fairly low; firms that undertook IPOs typically are well-established, large firms; and venture
capital is inactive in the Italian market. In contrast, the IPO market in the US is characterized by
high liquidity, abundance of small firms and growth-oriented firms, and active participation by
venture capitalists.
The IPO markets in some Asian countries exhibit characteristics that are more similar to the
US market than to the Italian market. For instance, the venture capital market is fairly active in
Taiwan, which is not surprising in that many executives, scientists, and entrepreneurs are familiar
with the US market and, in many cases, trained in the US. 2 More important to our study, pre-issue
data is available for most firms in Taiwan owing to regulations. Specifically, the government
requires all firms that exceed a minimum asset size to file financial statements with the SEC there,
even if their shares are not publicly traded.
In order to make our results comparable to those in PPZ (1998), we use a methodology that
closely follows theirs. Moreover, we have additional data unavailable in their study.
Consequently, we extend their study by including venture capital involvement, free cash flows,
and R&D expenditures in the analysis. To test for the possibility that IPOs facilitate merger and
acquisitions (M&A), we examine post IPO M&A activities, following the methodology in Brau
and Fawcett (2006).

Wang-Pin Shen, Department of Finance, Yuan Ze University, Taiwan, finyps@satum.yzu.edu.tw; and Peihwang
Wei, Department of Economics and Finance, University of New Orleans, New Orleans, LA 70148, (504)280-6602,
pwei@uno.edu. We would like to thank an anonymous referee for helpful comments and our assistant Jia-chi Chin for
excellent assistance.
i Anotheris Lerner(1994) that finds market-to-bookratio is an importantdeterminantof going public. However,he
examines only one industry: Biotech.
2The numberof venture capital finns in Taiwan is 48 in 1996 and 199 in 2001.
360 JOURNAL OF ECONOMICS AND FINANCE 9 Volume 31 9 Number 3 9 Fall 2007

We find some differences between results of PPZ (1998) and ours. Consistent with their
evidence, we show that the probability of going public is greater for larger and profitable firms.
Unlike theirs, we do not find strong evidence that firms in industries with higher industry market-
to-book ratios are prone to issue new shares. In fact, for firms that are not in the electronics
industry, the tendency is the opposite. PPZ (1998) also conclude that the primary motive for firms
to raise fund through public offering is restructure of financing or a reduction of the outstanding
debt. Our results, on the other hand, imply that financing need is not a strong motive for IPO. We
also find evidence that the involvement of venture capital raises the likelihood of going IPO and
that IPO firms tend to engage in M&As.

Literature Review

Brau and Fawcett (2006) and PPZ (1998) summarize the theoretical motives for firms to go
public, as follows. The benefits from IPOs include enhanced diversification and cash-out
opportunities for insiders (Pagano, 1993, and Zingales, 1995), resolution of information asymmetry
(Myers and Majulf, 1984, and Chemmanur and Fulghieri, 1999) and facilitation of future merger
and acquisitions (Zignales, 1995). Myers and Majulf (1984) posit a pecking order of financing,
with equity financing being at the bottom of the order resulting from a greater degree of
information asymmetry for equity. Chemmanur and Fulghieri (1999) argue that the reduction in
information asymmetry for small firms is likely not greater than risk premium demanded by
private investors, implying that it is more difficult for small firms to go public. There are other
benefits suggested by the literature, but due to the lack of data or adequate measures, we provide
no explicit testing for them: broader investor base (Merton, 1987), name recognition and publicity
(Brau, et al., 2003, and Maksimovic and Pichler, 2001), increased liquidity, increased bargaining
position with banks (Rajan, 1992), exploitation of mispricing (Ritter, 1991), and upward-biased
analysts' opinions following IPOs (Bradley et al., 2003). The combined effect of these potential
benefits is a reduction in cost of capital, but the costs of IPOs may be high also, including the
investment bank fees and loss of control and confidentiality (e.g., Yosha, 1995).
Based on the theories mentioned above, PPZ (1998) develop the following testable
hypotheses. The presence of information asymmetry or substantial issuance costs or desire for
liquidity (so that shareholders and initial owners can achieve diversification) would give large
firms comparative advantages in IPOs. Firms with higher R&D activities and those in the high-
tech industries are likely more sensitive to confidentiality, suggesting firms with greater R&D
expenses may avoid IPOs. Due to the unavailability of data, this hypothesis is not tested in PPZ
(1998). If firms go IPOs to gain access to equity markets, then firms with high greater growth
potential would opt for IPOs.
PPZ (1998) then utilize a private database obtained from the backing sector in Italy to conduct
the only direct empirical test of the above theories. PPZ's database contains a large number of
firms, both private and public. After eliminating small firms for whom information is unavailable,
their final sample consists of approximately 12,000 private firms and 69 firms that went public for
the sample period of 1982 to 1992. The percentage of firms that went public is tiny compared to
the US market, and they speculate that a similar percentage applies to other European countries,
probably due to the relatively lower degree of protection for minority shareholders in Europe.
Moreover, the breath of the IPO market is fairly low; firms that undertook IPOs typically are well-
established, large firms; and venture capital is inactive in the Italian market. They found that two
variables are significantly positively related to the probability of IPO: market/book ratio and firm
size. The positive correlation between market/book ratio and IPOs suggests that firms with greater
investment opportunities, as measured by market/book ratio, tend to go public. However, they find
that profitability of the IPO firms decline after issuance. Therefore, they suggest that restructure of
financing and not growth opportunities are the underlying driving force for firms to sell new
equity to the public.
 JOURNAL O F ECONOMICS AND FINANCE 9 Volume 31 , Number 3 9 Fall 2007 361

A more recent paper by Brau and Fawcett (2006) conduct a survey of chief financial officers
in both public and private firms in the U.S. They received 336 responses, representing 18.8% of
their mailing list. On the question concerning motivation for IPOs, only two motives were
indicated as important by more than half of CFOs in the survey: "IPOs serve to create shares for
use in future acquisitions" and "the establishment of market price." (They also ask questions on
other issues related to IPOs.) To further examine the acquisition motive, they compile data on
M&As subsequent to IPOs. They find that IPO firms were acquirers 141 times, compared to 96 for
industry and size matched sample of other publicly traded firms. The difference is statistically
significant. In contrast, the IPO firms were seldom targets of acquisitions; they were targets only
18 times, which is not significantly different from the 17 times for the benchmark firms.
Therefore, they conclude that the most important reason to go public is to enable a firm to make
use of public-traded stock as an acquisition to01. Nevertheless, they acknowledge that the survey
method may be subject to response bias and that the results might not necessarily carry over to
other time periods (theirs is 2000 to 2002).

Sample, Methodology and Hypotheses

Our sample covers the Taiwan stock market in the period of 1989 to 2000 and consists of 383
firms that went IPOs and 522 firms that met listing requirements but chose not to go for IPOs in
the period. The data source is Taiwan Economic Journal, which contains financial statements of
all firms, publicly traded or not. The information on venture capital involvement comes from the
venture capital association in Taiwan. In Taiwan, listing requirements are well defined though
vary across time. 3 Also, the listing requirements of the over-the-counter (OTC) market generally
are less stringer than those used in Taiwan Stock Exchange (TSE). As a result, we need to
carefully examine all financial statements to screen out those that satisfy the requirements but
elect not to undertake IPOs. The following Probit regression is then employed to estimate the
probability of IPO. Note that the regression makes use of both cross-sectional and time-series data.
After a firm undertakes IPO, the firm's data on subsequent years is not used in the regression
analysis. The sampling procedure and regression closely follows those of PPZ (1998), so
differences in the results cannot be attributable to variations in methodologies. Nevertheless, we
do extend their analysis by including variables that reflect venture capital participation, free cash
flows, and R&D expenses. Additionally, the OTC market was not established until 1995, thus we
repeat the analysis for the sub-period 1995-2000. This can also serve as a robustness check. 4 The
Probit regression is stated as follows.

Prob (IPOi.t) =F(ff.I*SALESi,t_I+~t2*CAPEXi,t-1+ff.3*R&Di,t-I+Ot4*ROAit-I

+06*D/Ai,t.l +0.6*INTi,t_l+~7*M/Bi,t_l+(18*GROWTHi,t_I+ff.9*FCFi,t_1"1"~10*WCi,t-1)

where IPOi.t is a dummy variable that takes on the value of one for i'th firm that goes IPO in year
t; SALES is the log of sales a year before; CAPEX represents the rate of increase in fixed assets;
R&D is computed as R&D expense over total assets; ROA is EBIT divided by total assets; ; D / A
represents the debt-to-asset ratio; INT measures effective interest rate, estimated by interest plus
amortization expenses divided by the outstanding debt amount; M/B is the industry median
market-to-book ratio; GROWTH is sales growth rate; FCF is free cash flow, calculated as income

3 For example, in 1995, the primarylisting standards for Taiwan Stock Exchangeare: capital is in excess of NT$0.2
billion (roughly$6 million using current exchange rate), pre-taxreturn on capital has been at least 5% for two consecutive
years, numberof shareholders is at least 2,000, and that equity ratio is over 1/3. The OTC requirements are less demanding
and have no restrictions on equity ratios.
4 PPZ (1998) performseparate analysesof carve-outsand independent companies.We do not do that here, since carve-
outs are veryfew in Taiwan.
362 JOURNAL OF ECONOMICS AND FINANCE 9 Volume 31 eNumber 3 9 Fall 2007

before interest, tax, and depreciation minus interest and dividends, normalized by total assets; and
VC is a dummy variable that equals one if venture capital is involved and zero otherwise. As in
PPZ (1998), a variable that represents the year when IPO is conducted is added to the regression
but not reported.
The hypothesized signs of these variables are discussed by PPZ (1998) and summarized in
Table II of that paper. Consequently, we will just outline their conclusions, as stated below. The
presence of information asymmetry or substantial issuance costs or desire for liquidity would give
large firms comparative advantages in IPOs, and therefore the hypothesized sign of SALES is
positive. Firms with higher R&D activities and those in the high-tech industries are likely more
sensitive to confidentiality, suggesting a negative coefficient for R&D. If firms go IPOs to gain
access to equity markets, then firms with high CAPEX, high D/A, and high GROWTH or M/B
would more likely go for IPOs, assuming that growth potential is appropriately measured by M/B.
Using a similar logic, firms facing high INT tend to issue new equity. Nevertheless, it should be
pointed out that a positive coefficient on M/B could also suggest some market-timing ability. With
regard to ROA, the expected sign is undetermined. More profitable firms are more likely to satisfy
listing criterion and more likely to be embraced by investors. On the other hand, profitable firms
have little incentives to seek external financing.
PPZ (1998) also mention another possible motive for IPO but do not offer a way to test it: the
desire for original owners to diversify. Based on the argument of Pagano (1993) that riskier firms
would be more inclined to seek public listing due to diversification desire, we develop the
following hypotheses. Arguably, riskier firms are characterized by high interest rate (since interest
rate should incorporate a risk premium) and less free cash flow. To the extent that these two
variables are good proxies for riskiness, the expected signs for coefficients of INT and FCF are
positive and negative, respectively. The coefficient of free cash flow, FCF, also is predicted to be
negative if firms prefer to use internally generated capital and would use external funds only if
they cannot produce sufficient cash flows (Myers and Majulf, 1984). In addition, high cash flows
might be a symptom of agency problems thus a lower propensity for IPO. Megginson and Weiss
(1991), Gompers (1995), and Lerner (1995) suggest that venture capitalists provide a certification
function; if so, the engagement of venture capital would raise the probability of listing. Therefore,
we hypothesize that the coefficient of VC is positive.

Empirical Results
Table 1 compares the IPO firms and firms that satisfied listing criteria but have not elected to
do so. Because the following regression analysis will pool the cross-sectional and time-series data,
we choose to present strictly cross-sectional data here, based on the financial data in the year of
2000. We expect to see fewer differences between IPO and non-IPO firms over a long period of
time, but the patterns are remarkably similar to those in the following regression analysis,
implying the results here are fairly robust across time. The table indicates that IPO firms have
significantly greater size (in terms of sales), R&D, and profitability (measured by return on assets)
but their debt ratios are on average lower. The initial evidence implies that IPOs are not strongly
motivated by financing needs: if financing need or constraint is the predominant consideration, we
would expect smaller, less profitable and highly levered firms to seek listing, but the results point
to the opposite. The result on R&D is somewhat surprising and is inconsistent with confidentiality
being a major concern. This may to some extent reflects the fact that a considerable proportion of
IPOs in Taiwan is in the electronic industry that tends to have high R&D costs. Therefore, in the
following Probit regression, we present separate analyses on the sub-samples of the electronic
industry and of all other industries. The Probit results are displayed in Table 2. Note that the
majority of observations occur after 1995, reflecting the facts that the Taiwan market is largely
illiquid and that venture capital is virtually non-existing before 1995. Furthermore, the OTC
market was not established until 1995.
 J O U R N A L O F E C O N O M I C S A N D F I N A N C E 9 Volume 31 9 N u m b e r 3 9 Fall 2007 363

Table h Summary Statistics

Panel A: IPO firms
mean median sd min max n
SALES 14.05 13.97 1.09 0.00 19.05 383
R&D (%) 1.76 0.55 3.58 0.00 48.89 383
ROA (%) 13.72 12.19 9.02 -23.50 87.50 383
D/A (%) 47.50 47.41 17.21 1.89 107.28 383
INT (%) 9.27 7.84 29.32 0.00 1351.35 383
M/B 1.28 1.30 0.44 0.42 3.61 383
GROWTH (%) 41.92 17.77 450.94 -98.62 22645.38 383
FCF (in million of NT$) 51.62 16.06 390.86 -81.04 10959.35 383

Panel B: non-IPO firms

mean median sd min max n
SALES 14.24 14.22 1.39 0.00 19.98 522
R&D (%) 0.79 0.00 1.88 0.00 26.45 522
ROA (%) 8.59 8.27 8.34 -87.09 46.76 522
D/A (%) 50.45 51.29 21.17 0.17 195.18 522
INT (%) 8.13 7.57 15.36 0.00 442.43 522
M/B 1.25 1.27 0.44 0.42 3.61 522
GROWTH (%) 8.81 4.81 68.61 -127.78 2277.68 522
FCF (in million of NT$) 47.88 19.59 230.42 -476.03 6254.57 522
Notes: Sales are shown as the log of amount in NT$1,000 (New Taiwan dollars). The means of R&D and ROA are
significantlydifferentat 1% betweenIPO and non-IPOfirms and the means of SALESand D/A are significantlydifferent
at 5%, accordingto the t test.

Consistent with the results in PPZ (1998), the correlation of IPO with either SIZE or ROA is
positive. The positive sign of SIZE coefficient is in agreement with information asymmetry, listing
costs, and liquidity being relevant factors for initial owners. In contrast to their study where M/B
was found to be a major determinant, we find M/B is significantly positively related to IPO only
for the entire sample but not for industries outside electronics. In fact, in the regression that
excludes the industry of electronics, the coefficient of M/B is negative though statistically
insignificant. Thus the evidence in favor of market-timing ability is rather weak.
Perhaps our most striking result is that many coefficients are contrary to the notion that IPO
arises from the need for financing or as an attempt to seek alternative financing sources. We reach
this conclusion by the observations described below. (a) The coefficient of CAPEX is negative
though significant only for electronics. (b) The coefficient of INT is negative if we use the OTC
listing standards. (c) The coefficient of GROWTH is negative though insignificant. (d) The
coefficient of debt (D/A) is significantly negative. (e) Profitability as measured by ROA increases
the probability of listing. Taken together, they imply that the greater the expenditure, the lower the
probability of IPO. Therefore, we interpret that the overall evidence against IPO being motivated
by financing need and/or constraint as fairly strong.
364 JOURNAL O F ECONOMICS AND FINANCE 9 Volume 31 9 3 9 Fall 2007

Table 2: Probit Analysis of the Probability of Going IPO

period 1989-2000(TSE standards) 1995-2000(TSE standards) 1995-2000(OTC standards)

All Firms Electronics others All Firms Electronics others All Firms Electronics others

0.177"* 0.398* 0,110"* 0,135"* 0.405** 0.030 0.240** 0.528** 0.121"*

SALES
(0.029) (0.062) (0.036) (0.033) (0.068) (0.042) (0.032) (0.061) (0,045)

-0.000 -0.001"* -0.000 -0.000 -0.001" -0.000 0.240 -0.001** -0.000

CAPEX
(0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.032) (0.001) (0.001)

0.029** 0.009 0.030* 0.033** 0.013 0.038** 0.035** 0.014" 0.039'*

R&D
(0.008) (0.012) (0.018) (0.009) (0.012) (0.019) (0.004) (0.006) (0.006)

0.010"* 0.002 0.012" 0.009* -0.001 0.010 0.007** 0.001 0.008

ROA
(0.003) (0.005) (0.004) (0.004) (0.006) (0.007) (0.004) (0.00l) (0.007)

-O.OlO** -0.022** -0.009** -0.009** -0.022** -0.007** -0.129"* -0.026** 0.007**

D/A
(0.002) (0.004) (0.002) (0.002) (0.004) (0.003) (0.002) (0.004)
(0.003)

INT
0.001 -0.001 0.002 0.004 0.000 0.006 -0.109 -0,057** 0.174**
(0.003) (0.004) (0.004) (0.003) (0.004) (0.005) (0.008) (0.012)
(0.001)

0.163"* -0.168 0.282** -0.268 -0.001 -0.047

M/B
(0.062) (0.112) (0.083) (0.170) (0.002) (0.182)

-0.000 -0.000 -0.000 -0.000 -0.000 -0.000 -0.000 -0.000 -0.000

GROWTH
(0.001) (0.001) (0.001) (0.001) (0.00l) (0.001) (0.001) (0.001) (0.001)

-0.000 -0.001 -0.000 -0.000 -0.001 -0.000 -0.000 -0.001" -0.000

FCF
(0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001) (0.001)

0.447** 0.374** 0.266 0.560** 0.419"* 0.543**

VC
(0.095) (0.130) (0.157) (0.094) (0.125) (0.163)

n 2918 748 2170 2154 678 1476 3080 799 2281

Log
-1378.27 -457.27 -870.71 -1025.39 -391.85 -592.07 -1035.42 -446.75 -520.40
Likelihood

Note: The numbersrepresentcoefficientsin the regression.Standarderrors are in parentheses.The signs ** and * indicate
significantat 1% and 5%, respectively.

The table also shows that the probability of IPO is positively related to R&D expenditure. As
stated earlier, this is inconsistent with confidentially being a major factor. We feel that to a large
extent this result can be explained by the fact that the electronic industry, as a whole, tends to have
greater R&D and tends to favor IPOs. Stated differently, the result here may be a reflection of
higher probability for an electronic firm to seek listing. When we examine only the electronic
 JOURNAL OF ECONOMICS AND FINANCE 9 Volume 31 9 Number 3 9 Fall 2007 365
industry, this coefficient becomes insignificant, which might be due to the lack of variations in
R&D expenditures in this industry - it is plausible that competition among electronic firms is so
intense that most firms consider R&D necessary and unavoidable activities.
The negative sign of D/A is clearly a piece of evidence against IPO as a solution for financial
restructure. The trouble with this result is that no existing theory seems to be capable of explaining
the negative sign. A possible explanation is that firms with high debt may be firms with financial
difficulties and/or considerable information asymmetry, thus they are unlikely to meet the listing
requirements. Another reason for this result is TSE's requirement that equity must be at least 1/3
of assets, which would deny firms with high debt ratios. However, the OTC market imposes no
such requirement and yet the result is qualitatively the same.
There is some evidence supporting IPO as a means for initial owners to diversify.
Specifically, lower amount of cash flow implies a riskier firm thus greater probability of IPO,
which is confirmed by the negative coefficient on FCF. On the other hand, the coefficient of INT
is not unambiguously positive, as would be expected if diversification is an important driving
force.
The result on venture capital is uniformly positive using any sample. This is consistent with
venture capital serving as a certification agent. The participation by venture capital likely
enhances managerial efficiency and transparency thus promoting investor confidence and the
likelihood of going public. 5
To investigate the role of IPOs in future M&As, we match each IPO firm with another firm
that has not issued equity in the five years prior to the IPO date. The matching firm has the closet
firm size and market-to-book ratio and must be in the same industry; the latter requirement
reduces the sample size for matching firms by five since comparable firms in the same industry
that meet the criteria mentioned above are unavailable. The methodology follows that of Brau and
Fawcett (2006) and the results also are generally consistent with theirs. As shown in Table 3, we
find that 26% of IPO firms were acquirers subsequent to IPOs, significantly more than the 9% for
non-IPO comparable firms. On the other hand, IPO firms were seldom targets in M&As,
representing roughly 3% of all IPO firms (based on Brau and Fawcett, in the U.S., roughly 42% of
IPO firms were acquirers while about 5% were targets). Thus, the evidence is also supportive of
IPO as a stage preceding M&A activities.

Table 3: Comparison of Merger Activities of IPO firms and

Matching Firms that Have Not Conducted Security Offerings in Preceding Five Years
IPO firms Matching firms Difference in terms of percentage
(559 firms) (554 firms) of the sample
Acquirer 146 (26%) 49 (9%) 17%**

Target 18 (3%) 11 (2%) 1%

Total 164 (29%) 60 (11%) 18%**

Note: The sign ** indicates the differenceis statisticallysignificantat the 1% level,based on chi-squaretest.

Venture capitalis relativelyinactivebefore 1995;thus we do not includethis variablefor the entireperiod.

366 JOURNAL
OF ECONOMICSAND FINANCE 9 Volume 31 9Number 3 9 Fall 2007

Conclusions

In this study, we examine the determinants of firms' IPO decisions in Taiwan, for the sample
period of 1989 to 2000. The regulations in Taiwan permit us to identify firms that met IPO
requirements but chose not to go public. The unique regulatory environment allows a clear
comparison of firms that choose IPOs and those that do not.
With the exception of Pagano, Panetta and Zingales (1998), we are not aware of any similar
study. Their paper examines the IPO market in Italy, and there seem to be considerable differences
between that market and Taiwan market. Indeed, we find strong evidence that IPOs are not
motivated by financing needs or constraints while they do. (Our finding is consistent with Brau
and Fawcett (2006)'s survey result that financing needs are not considered as important by CFOs
in the U.S.) Some of our results are nevertheless consistent with PPZ (1998) -- in particular, we
find that larger and profitable firms are more likely to list equity. Our other findings also provide
support for, though not overwhelmingly, information asymmetry, listing costs, liquidity, owners'
diversification desire, and market timing as factors influencing IPO decisions. In addition, we
present evidence strongly consistent with venture capital providing certification to firm credibility.
Finally, post-IPO M&A activities are more for newly IPO firms, consistent with the notion that
going public produces a new equity that can assist in future M&As; they are also consistent with
the results in Brau and Fawcett (2006). However, given our evidence supporting other motives for
IPOs, we hesitate to conclude as in Brau and Fawcett (2006) that "primary motivation for going
public is to facilitate acquisitions." The results using the Taiwan market may be more relevant to
US investors, since in many aspects this market is more similar to the US than to the Italian
market where IPOs are infrequent events and venture capital is inactive.

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