How Do Venture Investments by Different Classes of Financial Institutions Affect the Equity Underwriting Process?

Abstract:     
Over the 1993-2000 period, a majority of U.S. venture-backed IPOs have venture backing by financial institutions. Each class of financial institutions has its own asset expertise, investment criteria and access to proprietary information on private firms, which we exploit evaluating whether venture investments by commercial banks, investment banks and insurance companies have independent effects on the equity underwriting process. We also examine whether these effects are a function of investment size and whether the effects differ for debt (loans) and equity investments. We find that each class of financial institutions making venture investments in a firm going public is associated with evidence of lower adverse selection risk; namely reduced underpricing and absolute offer price revisions and stronger long-term operating performance. The impacts of debt or equity investments by separate classes of financial institutions are largely additive. Moreover, the size of financial institution ownership in an issuer is more informative than the presence of financial institution investors. This body of evidence is consistent with equity holdings and loans by each class of financial institutions providing independent certification of issuer quality.

Keywords: IPO, Underpricing of Stock Offers, Venture Capital, Financial Institutions, Certification Hypothesis, Conflict of Interest, Underwriting

JEL Classifications: G24, G21, G14, G2, D81, D82, K22, K23, M13, M21

Working Paper Series