An Analysis of Adverse Selection, Entrepreneurial Activity, and the Decision to Go Public

We study a regional economy with a large number of entrepreneurs who own firms and who want to go public. Specifically, our analysis focuses on the contractual interaction between a representative risk averse entrepreneur who owns a firm and a risk neutral monopolistic investment bank that proposes the terms of the initial public offering (IPO) that is placed in the market. First, we determine the terms of the IPO when there is full information. Second, we describe the attributes of the entrepreneur/bank contractual interaction when this interaction is framed as a screening problem with adverse selection. Third, we solve this screening problem fully and then we discuss the properties of the optimal solution. Finally, we point out how the preceding optimal solution is impacted when there is competition between investment banks