Does Internal Capital Facilitate Access to External Financing? Evidence from IPOs by Family Business Groups

Ronald W. Masulis

University of New South Wales – Australian School of Business; European Corporate Governance Institute (ECGI); Financial Research Network (FIRN)

Peter K. Pham

Australian School of Business – University of New South Wales; Financial Research Network (FIRN)

Jason Zein

UNSW Business School; Financial Research Network (FIRN)


Recent theories highlight important financing advantages of family business groups, but the channels through which these advantages operate to support external fundraising remain empirically unexplored. Studying a panel of groups across countries, we show that internal capital facilitates the IPOs of new group affiliates. Internal capital accumulation predicts which groups conduct IPOs and their timing, which existing affiliate(s) sponsors an issue, and the extent of external equity raised. Consistent with internal capital support benefits, groups float large and difficult-to-finance firms, often in weak issuing markets, that incur lower flotation costs and better weather negative post-listing market conditions than unaffiliated IPOs.

Does Internal Capital Facilitate Access to External Financing? Evidence from IPOs by Family Business Groups – Introduction

Across the world, the growth of new ventures is often severely constrained by an inability to raise external equity capital. In some economies, this funding gap is bridged by angel investors and venture capitalists, but in many others, contracting mechanisms and property right protections are insufficiently developed to support substantial venture capital activity.

A parallel disparity also exists in the extant literature. While the role venture capitalists play in facilitating stock market access in developed economies has received extensive analysis, much less is known about how young firms overcome external financing barriers in other parts of the world. This study focuses on one major source of funding support for such firms – namely, internal equity investments by business groups. Our analysis is motivated by the pervasive nature of business group participation in international initial public offering (IPO) markets. In particular, our data reveals that on average 29 percent of new issue proceeds in each country is attributable to group-affiliated firms. This raises an important question regarding the role business groups play in assisting new firms seeking to tap public equity markets.

Prior studies suggest that business groups have both a dark and a bright side. On the dark side, their ownership structures allow controlling shareholders to hold voting rights in excess of their cash flow rights, which facilitates the consumption of private benefits. On the bright side, a group’s reputation, implicit guarantees, and access to internal capital can provide significant financing advantages.1 For young firms with high investment needs, recent evidence indicates that the net effect of group affiliation is positive (Almeida, Park, Subrahmanyam, and Wolfenzon (2011), Masulis, Pham, and Zein (2011), and Bena and Ortiz-Molina (2013)). Yet, the specific channels through which member firms benefit from group support remain relatively unexplored in the empirical literature. In particular, there is limited evidence on the financing advantages of group affiliation in the context of raising external equity capital. Our study fills this gap by analyzing IPO transactions of privately held group firms to provide insights into a potentially valuable support channel arising from a group’s ability to utilize internal capital to support the going public efforts of affiliates.

In general, a young firm’s access to new equity is constrained by the price discount that public investors require as compensation for adverse selection and moral hazard risks associated with investing in unestablished ventures. This can excessively dilute an entrepreneur’s shareholding and prevent a firm from raising sufficient capital, thus delaying profitable investments. According to existing theories, business groups possess significant advantages over independent entrepreneurs in overcoming such external financing constraints. Almeida and Wolfenzon (2006), for example, argue that groups can utilize a pyramidal structure to transfer internal capital from an existing affiliate (parent) to help minimize costly external funding by a new affiliate. Gomes (2000) suggests that by allowing new equity capital to be raised while ensuring continued control, pyramids expand the scope for capital market discipline from future share sales. This strengthens the implicit commitment of a group’s controlling shareholder not to expropriate and ultimately enhances their ability to take new firms public. Gopalan, Nanda, and Seru (2014) further argue that the controlling shareholder of a group can reallocate internal capital using dividends in order to maintain large shareholdings in member firms seeking to raise new equity, which in turn has the effect of lowering financing costs associated with public equity issues.


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