Divestment, Entrepreneurial Incentives and the Decision to go Public

This paper develops a theory of the life cycle of the firm based on incentive constraints.The optimal sale of the firm is restricted by entrepreneurial moral hazard and a lack of commitment regarding future divestment.This leads to a dynamic inefficiency that causes the entrepreneur to delay and to stagger the sale of the firm.The analysis provides a common explanation for a range of empirical phenomena related to initial public offerings (IPO's), such as the waiting time until firms go public, lock-up periods, operating underperformance of IPO's and post-IPO divestment.The equilibrium divestment process is shown to be (constrained) inefficient: entrepreneurs sell too late and too much of the firm.Recommendations for financial regulation that restore efficiency are derived.