Comments

This working paper was later retitled and published as:

Choi, Albert H. "Pricing Corporate Governance." UC Law Journal 75, no. 1 (2023): 67-114.

Abstract

This paper examines the long-standing debate over whether firms have a market-based incentive to adopt optimal governance provisions at their initial public offering (IPO). Various scholars and practitioners have argued that firms that offer stock to the public with suboptimal governance structure will be penalized by the market through a lower IPO price. At the same time, others have documented empirical evidence that many IPO firms have putatively suboptimal governance provisions, such as anti-takeover provisions and dual class structure, and many, especially those with dual-class structure, enjoy a market premium at their IPO. This paper attempts to bridge this gap. The paper’s main argument is that when different firms have different sets of optimal governance features (firm heterogeneity) and the investors have incomplete information on which governance features are optimal for which firms (informational issues), it becomes likely that the IPO process will not accurately price the governance arrangements. Due to such market failure, the incentive to adopt the (firm-specific) optimal governance provisions will diminish and firms with similar visible characteristics can adopt similar governance features even though they may be suboptimal for some firms. After presenting the baseline thesis, the paper examines various private ordering and regulatory mechanisms that could mitigate this market failure, such as a verification using a costly underwriter, more reliance on internal capital markets, deliberate underpricing, and potential post-IPO liability. The paper also presents some positive and normative implications, such as empirical predictions as to when we may expect to observe better pricing of governance regimes and the proposal over sunset provisions on dual class stock structure that convert dual-class to single-class stock after the IPO.

Disciplines

Corporate Finance | Law and Economics | Securities Law

Date of this Version

2-22-2022

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