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The Price of Rapid Exit in Venture Capital-Backed IPOs


Silvia Rossetto


University of Toulouse 1 - Toulouse School of Economics (TSE)

April 21, 2006

AFA 2006 Boston Meetings Paper

Abstract:     
This paper proposes an explanation for two empirical puzzles surrounding initial public offerings (IPOs). Firstly, it is well documented that IPO underpricing increases during "hot issue" periods. Secondly, venture capital (VC) backed IPOs are less underpriced than non venture capital backed IPOs during normal periods of activity, but the reverse is true during hot issue periods: VC backed IPOs are more underpriced than non VC backed ones. This paper shows that when IPOs are driven by the initial investor's desire to exit from an existing investment in order to finance a new venture, both the value of the new venture and the value of the existing firm to be sold in the IPO can be partially signalled by the investor's choice of price and fraction of shares sold in the IPO. When this is the case, the availability of attractive new ventures increases equilibrium underpricing, which is what we observe during hot issue periods. Moreover, I show that underpricing is affected by the severity of the moral hazard problem between an investor and the firm's manager. In the presence of a moral hazard problem the degree of equilibrium underpricing is more sensitive to changes in the value of the new venture. This can explain why venture capitalists, who often finance firms with more severe moral hazard problems, underprice IPOs less in normal periods, but underprice more strongly during hot issue periods. Further empirical implications relating the fraction of shares sold and the degree of underpricing are presented.

Number of Pages in PDF File: 36

Keywords: IPO, Venture Capital, Signaling, Exit

JEL Classification: C72, D82, G24, G31, G32

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Date posted: March 23, 2005  

Suggested Citation

Rossetto, Silvia, The Price of Rapid Exit in Venture Capital-Backed IPOs (April 21, 2006). AFA 2006 Boston Meetings Paper. Available at SSRN: http://ssrn.com/abstract=686704 or http://dx.doi.org/10.2139/ssrn.686704

Contact Information

Silvia Rossetto (Contact Author)
University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )
Place Anatole-France
Toulouse Cedex, F-31042
France
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