Equity - Bryan Yee

Which one is correct?

  • Private firms are generally smaller than public firms. Being smaller, they can have enhanced growth prospects because of easier access to growth capital.
  • Agency issues are usually greater at private companies.
  • Small companies might decide to remain privately held because higher compliance costs may outweigh any other benefits of being public.

For the first statement, I think private firm is harder to access capital because of its small size and higher risk.

For the second statement, I think if management and private firm shareholders are separated, private firm should have greater agency issues than public company. Public company should have less agency cost because it has audited and more reliable financial reporting statement and better corporate governce.

Why the third statement is correct?

I wish I had my Equity book on me but I recall that both public firms and private firms have agency costs.

The third statement is correct because when a firm goes public they have to adhere to public disclosure and stay up-to-date with laws etc. For example if a firm goes from private to public they will have to pay underwriting costs in addition to creating a compliance department which will be a new ongoing cost. These costs can all be saved by staying private.

But why private firm has less agency cost than public firm?

because for private firm the CEO is often the owner. on the other hand, a public company has to hire a management team to run the company. thus, there is a higher chance the management team will act on their own interest, not for the company’s shareholder

@lizihengtotti I believe the private and public companies have the SAME agency costs. One doesn’t have more agency costs than the other.

I found this in the Corporate Finance CFAI book. Hopefully it’s not too different from the Equity section.

Reading #22 Capital Structure, p104

2.5 Agency Costs

Agency costs are the costs associated with the fact that all public companies and the larger private companies are managed by non-owners. Agency costs are the incremental costs arising from _ conflicts of interest when an agent makes decisions for a principal _. In the context of a corporation, agency costs arise from conflicts of interest between managers, shareholders, and bondholders.

I think it is possible that private firm also hire a management team. In that case, management can also act on their own interest. However, public firm has more transparent and audited financial reporting statement and much larger and has better corporate governce, it should have less agency cost than private firm. Overall, public firm is public which means it is more transparent. So, it should have less agency cost. Right?

I agree with your assessment. @thanhnguyen504 is that right?

A public company is more likely to have non-owner management than a private company so its just a case of running the probabilities. A private company goes public and dilutes ownership, so there is no doubt there is a higher likelihood that new minority owners will have an agent acting on their behalf.

Don’t get too hung up on this, it’s great that you are thinking about this at a higher level but I’ve learned to keep that for when I’m applying what I’ve learned from my studies not when I am trying to pass an exam :slight_smile: