|By Business Wire
|January 15, 2013 12:01 AM EST
For many entrepreneurs, it is a dream on par with finding the Holy
Grail: an initial public stock offering that can turn a startup into the
next Google and a 20-something founder into the next mega-millionaire.
Yet, for all that money and drama, do initial public offerings — IPOs —
speed up technological innovation?
Not necessarily. An eye-popping new
study by Shai
Bernstein, an assistant professor of finance at the Stanford
Graduate School of Business, finds that innovation slowed
down by about 40 percent at tech companies after they went public.
In a meticulous analysis of patent data from nearly 2,000 companies,
Bernstein found that newly public companies became noticeably more
incremental and less ambitious with their in-house research than
comparable firms that stayed private.
And that’s not all. Top inventors were much more likely to leave if
their companies went public, and the ones who stayed behind showed a
steep decline in “innovation quality.” Indeed, the newly public tech
companies became much more dependent on buying technology from outside —
usually by making corporate acquisitions.
That’s almost the opposite of what one might expect. Young tech firms go
public on the strength of their innovative promise, and going public
provides them with cash to double down on their research and development.
From the vantage point of public policy, IPOs may still be a net
positive for tech innovation. Many companies go public because they have
just scored a major breakthrough and use their new resources to scale up
the business. And even if newly public companies do become less daring,
they can still propel innovation indirectly by paying top dollar for
startups. Google has bought 100 companies since it went public in 2004.
Facebook paid $1 billion for Instagram just as it was going public in
But Bernstein’s findings raise an important, but largely unexplored,
management issue: IPOs appear to spur the outsourcing of innovation. It
is a complex tradeoff, and one that tech entrepreneurs and investors may
want to examine in more depth.
Bernstein reached that conclusion after a detailed comparison of patent
data between companies that went public and similar companies that
decided to stay private. All told, the study covered thousands of tech
companies that either went public or withdrew IPO plans between 1985 and
To gauge “innovation,” Bernstein collected data on nearly 40,000 patents
awarded to companies both before and after they announced plans to go
public. In addition to tracking the absolute number of patents, he
estimated the innovative importance of each patent based on the number
of times it had been cited in other patent applications.
The basic idea is straightforward: Patents that are cited more
frequently are likely to represent more fundamental breakthroughs. But
Bernstein also estimated the “originality” of patents, based on how many
different technologies were cited. Last, but not least, he analyzed data
about the inventors themselves.
Bernstein compared two categories of companies: those that completed
public offerings and those that filed IPO registrations with the
Securities and Exchange Commission but later withdrew them. To make
apple-to-apple comparisons, he compared companies that were in the same
technology sectors and that contemplated public offerings in the same
He found that the two groups of companies had broadly similar
characteristics up to the point they decided to go public or stay
private. Both groups had high-quality patents that were much more
heavily cited than those of companies that didn’t try to go public. The
two groups were also similar in size, age, and research spending. And
there were no significant differences in the quality of the IPO
underwriters, which is often a proxy for the quality of the companies.
Not surprisingly, the biggest distinction between the companies that
went public and those that stayed private was the stock market’s
appetite at the time. If the tech-heavy NASDAQ went into a swoon just
after a company filed to go public, the company was much more likely to
call off its plans. Almost one third of all the abandoned IPOs between
1985 and 2003 occurred in 2000 — the year the dot-com bubble collapsed.
The real difference in innovation came after companies completed public
offerings. The average quality of those patents, as measured by how
often they were cited, declined by about 40 percent in the five years
after going public. By contrast, companies that remained private stayed
on the same track as before.
Bernstein also confirmed what even blockbuster companies in Silicon
Valley have worried about for years: IPOs can spark a brain drain.
He divided inventors into three categories: “stayers,” “leavers,” and
“newcomers.” Inventors were about 18 percent more likely to become
leavers at companies that went public. Much more startling, however, was
that the stayers saw a 48 percent decline in the quality of their
patents. Inevitably, IPO firms recruited large numbers of newcomers.
One explanation for the brain drain is that top inventors have little
incentive to stay after an IPO, in part because they often become
overnight millionaires. An IPO also dilutes an inventor’s stake in
subsequent breakthroughs because those future profits will be spread
among many more investors.
Bernstein suggests that yet another important reason for the brain drain
is that IPOs lead to different management incentives. Executives at
publicly held companies may become more cautious, for example, because
they are subject to market pressures and worry more about career threats
and takeovers, and feel pressure to tell investors a simple story.
To find out more, Bernstein compared companies with two different
management structures. In the first group, chief executives were also
chairmen of the board and had more autonomy to resist market pressures.
The second group had separate chairmen and chief executives, which
usually means the chief executive is less insulated from market pressure.
The result: Companies with separate board chairs and chief executives —
those more likely to be sensitive to outside investors — saw a much
bigger drop in innovation, and inventors were more likely to leave.
Bernstein cautions that initial public stock offerings still may be good
for innovation in general. Public companies may not be as
technologically ambitious or as willing to take risks as firms that stay
private, but public companies have better access to capital for tapping
innovation generated by smaller companies.
But going public clearly changes the mindset of companies, and that
might be a reason for some companies to think twice about the Holy Grail.
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