Public offerings decrease innovation at technology companies
TweetFollow Us on Twitter

Public offerings decrease innovation at technology companies

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 May 2012.

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 2003.

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 year.

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% more likely to become leavers at companies that went public. Much more startling, however, was that the stayers saw a 48% 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.

 
AAPL
$567.77
Apple Inc.
+43.02
GOOG
$525.16
Google Inc.
-1.78
MSFT
$39.86
Microsoft Corpora
+0.17
MacNews Search:
Community Search:

Latest Forum Discussions

See All
view counter

view counter
view counter
view counter
view counter
view counter
view counter

Pen & Ink Review
Pen & Ink Review By Jennifer Allen on April 24th, 2014 Our Rating: :: CONVENIENT ARTISTRYiPad Only App - Designed for the iPad Pen & Ink is an ideal way to sketch down some visual ideas or simply spark your imagination.   | Read more »
Sonic & All-Stars Racing Transformed...
Sonic & All-Stars Racing Transformed Now Free, to Add New Iconic Characters and Elements Posted by Tre Lawrence on April 24th, 2014 [ | Read more »
Soccer Rally 2 Review
Soccer Rally 2 Review By Carter Dotson on April 24th, 2014 Our Rating: :: GOALKEEPINGUniversal App - Designed for iPhone and iPad Soccer Rally 2 is the most serious vehicular soccer game ever created.   | Read more »
Galaxy Conquerors Review
Galaxy Conquerors Review By Jennifer Allen on April 24th, 2014 Our Rating: :: RETRO SHOOTINGUniversal App - Designed for iPhone and iPad Old school shooting is fun but inaccurate in Galaxy Conquerors.   | Read more »
Yomi Review
Yomi Review By Rob Thomas on April 24th, 2014 Our Rating: :: C-C-C-COMBO BREAKERiPad Only App - Designed for the iPad Round One – Fight! No quarters required for this iOS adaptation of a tabletop adaptation of the arcade fighting game genre. How’s that for a combo?   | Read more »
Injustice: Gods Among Us Updated with Ne...
Injustice: Gods Among Us Updated with New Characters, Leaderboards, Gear, and Online Multiplayer Posted by Rob Rich on April 24th, 2014 [ | Read more »
Spin It Review
Spin It Review By Jordan Minor on April 24th, 2014 Our Rating: :: SPIN ME RIGHT ROUNDUniversal App - Designed for iPhone and iPad Spin It has a fine puzzle game model, but its execution lacks energy.   | Read more »
Productivity App NoteSuite is Having its...
Productivity App NoteSuite is Having its Biggest Sale Ever, Just for One Week Posted by Rob Rich on April 24th, 2014 [ permalink ] | Read more »
Wayward Souls Review
Wayward Souls Review By Carter Dotson on April 24th, 2014 Our Rating: :: CARRY ON, WAYWARD SONUniversal App - Designed for iPhone and iPad Wayward Souls is a roguelike-inspired action-RPG that sets a high bar for other games to compare to.   | Read more »
The Sandbox Gets Update, Receives New Ca...
The Sandbox Gets Update, Receives New Campaign and New Elements Posted by Tre Lawrence on April 24th, 2014 [ permalink ] Universal App - Designed for iPhone and iPad | Read more »
All contents are Copyright 1984-2010 by Xplain Corporation. All rights reserved. Theme designed by Icreon.