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Shield Competitive Information or Share it with Potential Investors? What’s a New Firm to Do?

The initial public offering (IPO) has a big impact on a company’s growth. Audra Boone, the C.R. Williams Professor in Financial Services, researched how withholding competitively sensitive information at the IPO can benefit companies in the long run.

May 07,  2018

By Elaine Cole

When a company goes public, the SEC allows certain proprietary information to be redacted from publicly supplied contracts to shield the information from rivals. While this process preserves the firm’s competitive advantage, it also limits investors’ access to this information. Because the initial public offering is often the first opportunity for the public to learn details about a firm, distributing detailed information at this time is crucial. 

“New firms face trade-offs between competitive needs to protect proprietary information from rivals and investors’ needs for information to help value securities,” said Audra Boone, the C.R. Williams Professor in Financial Services. 

Publicly-traded firms must divulge an array of information to comply with SEC disclosure rules, but with approval they are allowed to redact information that is competitively sensitive, such as pricing terms, specifications, deadlines and milestone payments.

Boone’s research shows that approximately 40 percent of firms going public redact information from at least one material agreement at the IPO.

“The firms that redact information tend to be younger, have higher research and development expenses, receive venture capital backing and reside in more competitive industries,” Boone said. Thus, they face higher proprietary costs from disclosing information to rival firms.

There are pros and cons to redacting. On the plus side, shielding competitively sensitive information helps maintain competitive advantage and generate positive economic outcomes.

On the plus side, “IPO firms with redacted information have greater profitability, as measured by EBITDA to sales and ROA, and higher sales growth than industry peers in the three years following the IPO,” Boone said. 

On the down side, investors might produce less precise valuation estimates, leading to higher costs of raising capital. Boone’s research shows that redacting firms experience larger proportional first-day underpricing than those with full disclosure, even after controlling for other factors associated with first-day price increases. The effect is an approximate 7 percent of the difference between the offer price and close price on the first day of trading. The mean underpricing is approximately 21 percent.

Boone’s research shows that redacting firms use two tactics to offset the higher costs: conducting more follow-on equity offerings, and insiders selling shares at slower rates. Follow-on offerings enable firms to raise capital from investors after they are able to observe economic outcomes. Insiders selling shares at a slower rate helps certify that the redacted information is not negative information that managers want to hide. 

“At first glance, the large number of firms choosing to withhold information from material agreements is surprising given the costly implication on IPO pricing and the firm’s post-IPO information environment,” Boone said. “However, our research shows that firms ultimately benefit from higher peer-adjusted performance when both firms and insiders delay a portion of equity raising until after the firm has been public for some time.”

“Redacting Proprietary Information at the Initial Public Offering,” A. L. Boone, I.V. Floros, S.A. Johnson, Journal of Financial Economics, 2016