Effect of Book Building and Auctions on the Exit Choice between IPO and Acquisition

Abstract

The choice of exit mechanism between IPOs and acquisitions is an important decision faced by entrepreneurs and private equity investors. Although the decision to go public has been studied extensively, a firm’s choice between IPO and acquisition remains relatively unexplored. In this paper, we extend the existing literature by studying the effect of the type of IPO process on the decision. We introduce the two IPO methods: book building and auctions, and show how the parameters of the IPO methods affect the choice between IPOs and acquisitions. We show that for both the IPO methods, the probability of choosing IPOs decrease when cost to investors for acquiring information increases and fixed entry cost for investors increases. In the case of book building, we show that the probability of choosing IPOs decreases when the number of informed investors in the road-show increases. In the case of auctions, we show that the probability of choosing IPOs decreases when the certainty of the auction being successful decreases and the number of potential bidders increases. We analyse these extensions in two cases: when the firm is controlled by the entrepreneur and when the firm is controlled by the private equity investor. We also discuss important empirical implications which arise out of our theoretical model.