Determinants of the Round-to-Round Returns to Pre-Ipo Venture Capital Investments in U.S. Biotechnology Companies

44 Pages Posted: 8 Jan 2004

See all articles by John R. M. Hand

John R. M. Hand

University of North Carolina Kenan-Flagler Business School

Date Written: December 7, 2004

Abstract

I propose that pre-IPO venture-backed biotech companies offer a productive new setting through which to discriminate among theories of why firm size and book-to-market explain variation in expected stock returns. This is because pre-IPO biotech firms have large and rapidly evolving growth options relative to assets-in-place. Such attributes align closely with the key features of Berk, Green and Naik's (1999) model of the endogenous relations between growth options, optimal investment actions and expected equity returns, where firm size and book-to-market emerge as sufficient statistics for the aggregate risk of a firm's assets-in-place. Using venture capital investments in pre-IPO U.S. biotech companies during 1992-2001, I find that equity returns between financing rounds ("round-to-round" returns) are reliably negatively related to firm size and positively related to book-to-market ratios. These results are consistent with Berk, Green and Naik's theory. They are less consistent with competing explanations such as financial distress, behaviorally biased investors or data snooping.

Keywords: Biotechnology; book-to-market; firm size; growth options; risk; round-to-round returns; venture capital

JEL Classification: G12, L65, M13, M41

Suggested Citation

Hand, John R. M., Determinants of the Round-to-Round Returns to Pre-Ipo Venture Capital Investments in U.S. Biotechnology Companies (December 7, 2004). Available at SSRN: https://ssrn.com/abstract=484385 or http://dx.doi.org/10.2139/ssrn.484385

John R. M. Hand (Contact Author)

University of North Carolina Kenan-Flagler Business School ( email )

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Chapel Hill, NC 27599-3490
United States
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