Competitive advantages of going public: Evidence from incumbent firms in the USA

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Abstract

Industry incumbent firms (existing public peer firms) experience significant negative stock returns around large initial public offerings (IPO) events in the same industry (Hsu, Reed, & Rocholl, 2010), implying a competitive advantage shift resulting from IPO events. We investigate whether such large IPO events generate real impact in the long run and increase the risk and thus cost of equity of incumbent firms. Using data from 1998–2019, we found that within three years after large IPO events, industry incumbents exhibit positive abnormal returns even after controlling for known asset pricing factors. In addition, their default probability also increases. Using intertemporal capital asset pricing model (ICAPM), we show that incumbent firms’ stock returns become more sensitive to economic conditions, in other words, riskier. Following Hou and Robinson (2006), we propose that the increased risk to incumbent firms comes from industry competition. We provide empirical evidence that this is the case. Specifically, firms in industries with low product differentiability, a large number of public firms, and smaller market size have larger increases in expected returns. As robustness tests, we document that industry incumbents exhibit declines in unexpected earnings, which contradicts the notion that the observed positive returns can be attributed to persistent positive cash flow for industry incumbents.

Keywords: IPO, Competition, ICAPM, Industry Incumbent, Profitability, Financial Distress

Authors’ individual contribution: The Author is responsible for all the contributions to the paper according to CRediT (Contributor Roles Taxonomy) standards.

Declaration of conflicting interests: The Author declares that there is no conflict of interest.

Acknowledgements: We would like to express our great appreciation to faculty members in the University of Georgia Finance Department for all the guidance and advice they generously gave us. We would also like to thank all the attendees during our FMA 2015 presentation for the constructive comments they shared with us.

JEL Classification: G12, G14, G32

Received: 21.12.2021
Accepted: 29.03.2022
Published online: 31.03.2022

How to cite this paper: Han, S. (2022). Competitive advantages of going public: Evidence from incumbent firms in the USA. Corporate Ownership & Control, 19(3), 42–63. https://doi.org/10.22495/cocv19i3art3