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
$128.54
Apple Inc.
-0.82
GOOG
$573.37
Google Inc.
-0.27
MSFT
$43.06
Microsoft Corpora
-0.23
MacNews Search:
Community Search:
view counter

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

Warner Bros. Interactive Entertainment A...
Warner Bros. has some exciting games coming down the pipe! | Read more »
GDC 2015 – Star Trek Timelines will Prob...
GDC 2015 – Star Trek Timelines will Probably Make Your Inner Trekkie Squeal With Glee Posted by Rob Rich on March 4th, 2015 [ permalink ] Any popular fictional universe has its fair share of fan fiction – where belo | Read more »
Protect Yourself from an Onslaught of Ca...
Surprise Attack Games has announced a Cat-astrophic new physics puzzler called Fort Meow! In the game, a young girl named Nia finds her grandfather’s journal which triggers an all mighty feline attack! Why do the cats want the journal? Who knows, but you’ll have to protect it with pillow forts and over twenty items to discover. As you read the... | Read more »
GDC 2015 – Jelly Reef will be Game Oven’...
GDC 2015 – Jelly Reef will be Game Oven’s Last Hurrah, and it Seems like a Good Note to Go Out on Posted by Rob Rich on March 4th, 2015 [ permalink ] It’s sad knowing that Game Oven ( | Read more »
daWindci Deluxe Review
daWindci Deluxe Review By Campbell Bird on March 4th, 2015 Our Rating: :: BLUSTERY PUZZLESUniversal App - Designed for iPhone and iPad This updated puzzle game offers some creative gameplay and new mechanics, but still suffers from difficult controls.   | Read more »
Dungeon Hunter 5 Coming on March 12
Gameloft has excitedly announced that Dungeon Hunter 5 is on its way! Once again, you will adventure across the land of Valenthia exploring dungeons and fighting monsters. The game will have a new asynchronous multiplayer mode called Strongholds which lets you create a customizable base that you can defend and raid your opponents bases. | Read more »
GDC 2015 – The Sandbox 2 is Coming, and...
GDC 2015 – The Sandbox 2 is Coming, and Now it has Textures! | Read more »
Warner Bros. Interactive Announces Mort...
Mortal Kombat X, by Warner Bros. and NetherRealm Studios, will be a a free-to-play fighting/card-battle Mortal Kombat game. The game promises card collecting, multiplayer team combat, classic characters such as Scorpion, Sub-Zero and Raiden, and the ever popular fatalities that made the series famous. | Read more »
GDC 2015 – Piloteer is Whitaker Trebella...
GDC 2015 – Piloteer is Whitaker Trebella’s Latest Project, and it’s Definitely Something DIfferent Posted by Rob Rich on March 3rd, 2015 [ permalink ] You know | Read more »
PangoLand Review
PangoLand Review By Amy Solomon on March 3rd, 2015 Our Rating: :: COME VISIT PANGO AND FRIENDSUniversal App - Designed for iPhone and iPad PangoLand is an open-ended world full of familiar characters, bright colors and interactive appeal.   | Read more »
All contents are Copyright 1984-2010 by Xplain Corporation. All rights reserved. Theme designed by Icreon.