The Impact of Initial Public Offerings on Firm Market Capitalization: A Review of Theoretical and Practical Perspectives
By Joseph Mark Haykov
August 29, 2024
We begin by exploring the theoretical foundations underlying the observed increase in market capitalization that firms often experience following an Initial Public Offering (IPO) and subsequent listing on a public exchange. Drawing on mainstream financial theories, this study identifies several key factors contributing to this phenomenon, including the liquidity premium, enhanced access to capital markets, increased market perception and visibility, diversification of ownership, reduced cost of capital, signaling effects, and improved benchmarking and comparability. Each of these factors plays a critical role in shaping investor behavior and, consequently, the market valuation of newly public firms. The findings are supported by established academic literature, providing a comprehensive understanding of the mechanisms driving post-IPO valuation increases.
However, in the art world, IPOs offer additional benefits and advantages not generally applicable to other industries or markets. Specifically, in the case of fractional ownership of art through art-shares, the benefits of securitization far exceed those in other use cases, both theoretically and practically, as such securitization drastically increases the use value of art shares by not only ensuring guaranteed authenticity but also by limiting the available supply.
Introduction
When firms go public through an Initial Public Offering (IPO) and list their shares on major public exchanges, such as the New York Stock Exchange (NYSE), they frequently observe a substantial increase in market capitalization. The seven primary theoretical explanations within mainstream financial theory for this increase in firm value, focusing on the inherent advantages conferred by public listing, are outlined below:
Liquidity Premium: One of the most significant factors is the liquidity premium. Public listing greatly enhances the liquidity of a firm's shares, reducing the liquidity risk faced by investors. The increased liquidity leads to a higher valuation, as investors are generally willing to pay more for assets that can be easily traded in the market (Amihud & Mendelson, 1986).
Access to Capital Markets: Public listing provides firms with broader access to capital markets. The ability to raise funds from a wider pool of investors, including institutional investors, can facilitate growth and expansion, leading to an increase in firm value (Pagano, Panetta, & Zingales, 1998).
Market Perception and Visibility: Listing on a public exchange enhances a firm's visibility and credibility. The increased transparency and regulatory oversight associated with public companies reduce perceived risks, making the firm more attractive to a broader range of investors, which in turn drives up market capitalization (Merton, 1987).
Diversification of Ownership: The IPO process diversifies the firm's ownership, spreading risk among a larger base of investors. This diversification reduces the risk for any single investor, thereby making the firm's stock more attractive and increasing its market value (Shleifer & Vishny, 1986).
Reduced Cost of Capital: Going public often results in a lower cost of equity for the firm, as the liquidity premium and broader investor base decrease the required return on equity. This reduction in the cost of capital enhances the present value of future cash flows, leading to a higher valuation (Modigliani & Miller, 1958).
Signaling Theory: The decision to go public can also be interpreted as a positive signal to the market regarding the firm’s future prospects. Management's choice to list shares publicly is often seen as an indication of confidence in the firm’s growth potential, which can positively influence investor sentiment and increase market capitalization (Leland & Pyle, 1977).
Benchmarking and Comparability: Finally, once listed, a firm’s valuation is more easily benchmarked against industry peers. Publicly traded companies generally command higher valuation multiples compared to private firms, contributing to the increase in market capitalization post-IPO (Kim & Weisbach, 2008).
The substantial increase in market capitalization that firms often experience following an IPO can be attributed to several interrelated factors rooted in financial theory. By enhancing liquidity, expanding access to capital, improving market perception, and reducing the cost of capital, among other factors, going public provides firms with a multitude of benefits that collectively drive up their market value. These findings align with existing theoretical frameworks and are well-supported by academic literature.
However, the public listing of a portfolio of art carries an additional, particularly relevant benefit to the art world: proof of originality. In the luxury goods sector, which naturally includes artworks by Monet, Chagall, Picasso, Van Gogh, and others, an IPO also serves as a certificate of authenticity and exclusivity. This provides a crucial element of any luxury sales strategy—not just for art but also for other luxury items like Hermès bags or Patek Philippe watches. This certification effect enhances the perceived value of the listed assets by ensuring their authenticity and exclusivity, both of which are critical factors in the valuation of luxury goods.
Monetization and The Principle of Exclusion
The phenomenon of commercial goods possessing both use and exchange value has been recognized by numerous thinkers, from Aristotle to Adam Smith, due to its self-evident nature. Karl Marx also explored this concept in Das Kapital, where he distinguished between the subjective use value of a winter coat—its ability to keep the wearer warm—and the exchange value of the same object, determined by its market price. This concept aligns with William Stanley Jevons’ 1874 definition of money as a medium of exchange necessary to address the double coincidence of wants problem that hinders direct barter. It also corresponds with the Arrow-Debreu framework of mathematical economics, where an idealized perfect market—characterized by perfect competition, symmetric information, and fully unfettered trade—results in a theoretical Pareto-efficient equilibrium. In this framework, money is essential in its role as a unit of account in which prices are measured, allowing for the comparison of goods and services within this equilibrium.
In any economy, money serves not only as a medium of exchange but also as a unit of account for measuring the exchange value of goods and services relative to one another and to our wages, which limit our purchasing power. Consequently, money also functions as a store of value, as its role as a medium of exchange inherently restricts our ability to consume everything we desire. This is a well-established concept. As explained by the St. Louis Fed, in any real-world economy, both past and present, money consistently fulfills three key functions: as a unit of account, a medium of exchange, and a store of value. In the context of the use-exchange value duality, money is simply a unit of account in which the exchange value of goods and services is measured, as described by both the Arrow-Debreu framework and Marx in Das Kapital.
The fact that we measure exchange values through relative prices and wages expressed in units of money has no bearing on the principle that the higher the use value of any good or product available for sale, the higher its exchange value, all else being equal. For example, a bicycle is less costly than a car, which in turn is less costly than an airplane. The reason is self-evident: a car will get you to your destination faster than a bicycle, and an airplane offers even greater use value as transportation. However, as Adam Smith noted, the diamond-water paradox clearly demonstrates that to monetize any good or service, such as water or diamonds, the producer must be able to exclude non-paying customers from accessing the product, which means being able to prevent such individuals from obtaining any use value from it. This is why water, though essential, is inexpensive—it is so abundant that excluding others from accessing it is impractical, ensuring its low cost. Diamonds, however, while far less useful, are limited in quantity, and their exchange value is determined by the ability of producers like De Beers to exclude non-paying customers from claiming ownership of genuine diamonds.
The ability to exclude others from obtaining the use value of goods is even more crucial in the case of luxury items, such as paintings or sculptures, because their primary use value lies in signifying wealth, which necessitates the exclusion of others from claiming ownership. For this reason, limiting supply—thereby enhancing the exclusivity of a particular brand or product—and providing certificates of authenticity are critical in the luxury goods market. Indeed, it is an evidence-based claim that to monetize anything, especially luxury goods, non-paying customers must be excluded from ownership. Equally important is limiting the quantity to ensure exclusivity.
This principle is evident across various real-world markets. For example, though lab-grown diamonds are indistinguishable from natural diamonds—even under an electron microscope—their exchange value, as represented by market prices, differs by a factor of five. Similarly, an equivalent Patek Philippe watch or Hermès bag with and without a certificate of authenticity will fetch drastically different market prices. In the art world, the history and provenance, exemplified by a verified and provable chain of ownership, largely determine the exchange value of any historical piece of art.
Authenticity, provenance, and uniqueness are the key factors driving the price of art. This is why prints are worth significantly less than original paintings, and the same principle applies to sculptures. Provenance, authenticity, and exclusivity—limited quantity—are what drive the price of art. Indeed, it is precisely the fact that upon an artist’s death, the supply is forever limited that causes the prices of art by deceased artists to have a propensity to increase. This is why older artists may be particularly interested in TNT art shares.
TNT-Bank Art-Shares
TNT-Bank art-shares are fractional ownership certificates representing a stake in a collection of art, typically including all associated copyrights. These certificates entitle holders to a portion of any income generated by the underlying assets, with dividends distributed to fractional shareholders. Initially, this structure will be organized as a Regulation D partnership with the intention of later converting these certificates into liquid, tradable shares on various exchanges, including TNT-Bank, NYSE, NASDAQ, and others, depending on demand for the underlying asset portfolio. Liquidity is ensured through their availability for trading as TNT-Bank shares or tokens.
TNT-Bank shares—akin to NFTs—serve as a method for tracking fractional ownership of underlying assets on a public, peer-to-peer blockchain, maintained collectively by the fractional asset owners at a very low real-world cost. These shares represent ownership records that are collectively maintained by the shareholders, similar to how Bitcoin owners collectively maintain the Bitcoin blockchain. However, the TNT blockchain offers several advantages, which are detailed here: https://tnt.money/learn-more.
For the purposes of this discussion, the focus is not specifically on why TNT-Bank shares are superior to Ethereum smart contracts or third-party administrators, but on demonstrating the benefits of structuring a business that owns a portfolio of art generating income. This income can be derived from derivative artworks created under the original copyrights or from prints that are responsibly outsourced, all with the goal of maximizing long-term profits. This approach benefits every shareholder collectively, ensuring responsible management by an experienced gallery owner or custodian.
Moreover, this structure allows artists to receive future cash flows generated by their art, often well after their death, enabling them to enjoy the fruits of their labor during their lifetime. Although sales and profits will continue to accrue to shareholders long after the artists have passed, artists can now enjoy a better quality of life, supported by the income their work generates.
Importantly, this system encourages artists to manage their copyrights responsibly, avoiding the temptation to flood the market with artworks when in need of cash. An experienced custodian can optimize the supply and demand of these artworks to maximize future cash flows from sales to end-users, who can now easily show proof of ownership through TNT art-shares.
Additionally, custodians—who are experienced gallery owners—can be empowered to optimally manage the underlying portfolio by being issued "art-shares," aligning their interests with those of other shareholders. This incentivizes custodians to maximize long-term dividend income generated from the sale of related artworks. For instance, an artist's own gallery can be designated as the initial custodian of a well-defined subset of the artist's works and associated copyrights, which are the underlying assets the gallery aims to maximize in value. This is achieved by responsibly selling the copyrighted artworks in a manner that maximizes long-term dividends while providing an absolute guarantee of authenticity for any derivative artwork, as all such artworks are registered on the TNT blockchain as certified authentic.
By providing not only absolute proof of authenticity to the owners of the derivative artworks—including limited access to exclusive, read-only edition original full-resolution digital prints—but also giving the owners, collectively as a group, the ability to limit the supply of available derivative artworks, TNT-Bank art-shares become a valuable tool for any gallery owner or artist.
More importantly, the end-users, which means collectors—those deriving use value from the artwork—benefit by maximizing its market price through limited supply and certificates of authenticity, which they have the option to purchase at a reasonable cost. By maximizing the use value of their products for collectors who hang their art in their homes and resell it at auctions, artists increase the cash flow their products generate, both now and in the future, by maintaining stable auction prices and controlling supply. Naturally, this is only true for the "certified-authentic" TNT-Bank registered artworks, thereby allowing the artist the opportunity to re-authenticate their work.
This, in turn, increases the auction price at which these "certified-authentic, art-share backed" originals are sold, maximizing cash flows from both resale and new artwork at auctions and private sales. Naturally, the custodian in this case has the right of first refusal, thereby controlling the supply. Consequently, this also maximizes the value (the price) at which future copyright cash flows can be sold to the public. These benefits are further enhanced by the issuance of art-shares and the inherent advantages of an IPO, such as increased liquidity, higher valuations, a diversified investor base.
References:
Amihud, Y., & Mendelson, H. (1986). Asset Pricing and the Bid-Ask Spread. Journal of Financial Economics, 17(2), 223-249.
Kim, W., & Weisbach, M. S. (2008). Motivations for Public Equity Offers: An International Perspective. Journal of Financial Economics, 87(2), 281-307.
Leland, H. E., & Pyle, D. H. (1977). Informational Asymmetries, Financial Structure, and Financial Intermediation. The Journal of Finance, 32(2), 371-387.
Merton, R. C. (1987). A Simple Model of Capital Market Equilibrium with Incomplete Information. The Journal of Finance, 42(3), 483-510.
Modigliani, F., & Miller, M. H. (1958). The Cost of Capital, Corporation Finance and the Theory of Investment. The American Economic Review, 48(3), 261-297.
Pagano, M., Panetta, F., & Zingales, L. (1998). Why Do Companies Go Public? An Empirical Analysis. The Journal of Finance, 53(1), 27-64.
Shleifer, A., & Vishny, R. W. (1986). Large Shareholders and Corporate Control. The Journal of Political Economy, 94(3), 461-488.