Damodaran on Valuation

14.5. CONSEQUENCES OF ILLIQUIDITY

Illiquidity has consequences for almost every aspect of finance. The question of whether a company should go public may ultimately represent a trade-off between the control (associated with being the owner of a private business) and the liquidity of becoming a publicly traded firm. Investors, be they portfolio managers, private equity investors, or venture capitalists, will have to modify how they invest and what they invest in, based on liquidity, and performance evaluation and risk management tools have to grapple with illiquidity. Basic corporate finance measures (such as the cost of capital) may have to be adjusted to reflect illiquidity, and investment, financing, and dividend decisions will undoubtedly be affected by a firm's perception of its own liquidity (or lack thereof).

14.5.1. Going Public (or Private)

The question of whether a growing and successful private company should go public does involve trade-offs. It is true that publicly traded firms have more access to capital and provide more liquidity to their owners. It is also true that the owners of private businesses have far more control on how much information they reveal to markets and how their businesses get run. This trade-off between illiquidity and control will determine whether firms will go public in the first place.

Given that going public allows investors to trade on a firm's equity, and in effect reduce the illiquidity discount on value, we can draw the following conclusions ...