3. Private Firms & Public Firms

Question 1

Difference between private & public firms

Answer 1

Private firms:

• fewer choices for raising equity capital
• smaller and fewer shareholders, rely more on company’s retained earnings and venture capital or private equity

Public firms:

• more different kind of choices for raising equity capital
• examples: IPO, subsequent issues of common stock (Seasoned equity offerings), preferred stock, tracking stocks and warrants (call options)

Question 2

Paper - Brav

The level effect

Answer 2

Studies the effects that the relative cost of equity to debt capital is higher than that for public firms

Question 3

Paper - Brav

The level effect conclusions

Answer 3

a. Private firms are more likely to choose debt versus equity financing than public firms
b. The level of private firms’ debt ratios is higher than the level of their public counterparts’ debt ratios.

Question 4

Paper - Brav

The sensitivity effect

Answer 4

Studies the effect that the absolute cost of raising external capital are higher
for private firms than for public firms.

Question 5

Paper - Brav

The sensitivity effect conclusions

Answer 5

a. Private firms are less likely to visit the external capital markets
b. It is costlier for private firms to rebalance their leverage ratio
c. Private firms’ leverage ratio show larger sensitivity to operating performance.

Question 6

Why is private equity costlier than public equity?

Answer 6

• Issuing equity for private companies leads to loss of ownership and control
• Information asymmetry is higher for private firms, the cost of equity is therefore higher

Question 7

Paper - Brav

Conclusions on the difference in raising capital between private and public firms

Answer 7

• Public firms are significantly more likely than private firms to choose equity relative to debt
• Public firms are more likely to visit the external capital markets, either to raise or to retire capital