In the world of finance, companies are constantly faced with decisions that involve balancing risk, competition, and growth. One such decision revolves around equity financing, where businesses must choose how and when to raise money by selling shares. This choice may seem straightforward, but it’s more complicated than it appears.
Research by Associate Professor of Finance, Dr. Yianni Floros, co-authored with Dr. Konduru Sivaramakrishnan (Rice University) and Dr. Rustam Zufarov (University of Illinois Chicago), uncovers the hidden challenges companies face when deciding how to raise capital, particularly in protecting their competitive edge while accessing necessary funds.
The Challenge of Protecting Sensitive Information
At the heart of the research is the concept of proprietary costs—these are the risks a company faces when it reveals confidential information to the public. When companies seek to raise money by issuing shares to the public, they often need to disclose information that might give them a competitive advantage, like future business strategies, product innovations, or market insights. Their goal is to disclose information to lower their issuance costs. But there’s a catch: the more information a company discloses, the more vulnerable it becomes to competitors who can use that information against them. This leads to a tough decision—how much to share with potential investors without giving away too much to the competition. Potential investors want to know more about the issuing firm’s growth prospects, but competitors may use this revealed information causing.
Dr. Floros and his co-authors found that firms are often caught in a balancing act. They want to reduce the costs of issuing shares by being as transparent as possible with investors, but they also need to protect their sensitive, proprietary information. Sharing too much could hurt their competitive position, especially in industries where small details can make a big difference. The challenge becomes even more complex because the costs of revealing proprietary information vary from firm to firm. Some companies may feel more pressure to protect their secrets, while others can afford to be more transparent.
Measuring Proprietary Costs at the Firm Level
Until now, researchers have primarily measured proprietary costs at the industry level, assuming that all companies within the same industry face similar risks. However, Dr. Floros’ research takes an innovative approach by developing a method to measure proprietary costs at the firm level. This is significant because it acknowledges that companies—even within the same industry—can have vastly different strategies, market positions, and levels of competition. By capturing these differences, the model provides a more accurate picture of the risks firms face when choosing between public and private equity offerings.
For example, a tech company on the verge of launching a new product may have much higher proprietary costs compared to a company in the same industry that is less innovative. Dr. Floros’ research shows that firms with higher proprietary costs are more likely to opt for private placements when raising capital. In these private transactions, companies can share sensitive information with a select group of investors without making it available to the public. This way, they can protect their competitive edge while still raising the money they need to grow.
Why It Matters to the Average Investor
So, what does all this mean for the average person interested in finance or business? The research provides valuable insights into the decision-making process of companies when they raise capital. For investors, understanding the trade-offs companies make between transparency and competitiveness can shed light on why some firms choose private placements over public offerings. It also helps investors appreciate the delicate balance companies must strike to remain competitive while still attracting investment.
Additionally, Dr. Floros’ research opens new avenues for evaluating companies. Investors and analysts can use his firm-level proprietary cost measure to better understand the risks companies face when raising equity. This could lead to more informed investment decisions, as investors will have a clearer picture of which companies are protecting their competitive advantage and which are more revealing with the proprietary information they disclose.
In a world where information is power, Dr. Floros’ work helps to illuminate how companies can strategically navigate the challenges of raising capital without compromising their edge in the market. His research not only advances our understanding of proprietary costs but also gives both companies and investors new tools to make smarter, more informed decisions.
This research is featured in Review of Accounting Studies, “Proprietary Costs and the Equity Financing Choice,” Yianni Floros, Konduru Sivaramakrishnan, and Rustam Zufarov.
| Research@Lubar Faculty scholarship in the Lubar College of Business spans the business fields and beyond through both theoretical and applied research that is published in leading journals. Here are some of our faculty’s most recent publications: |
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