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The Role of Venture Capital Backing in Initial Public Offerings: Certification, Screening, or Market Power?

58 Pages Posted: 15 Oct 2004  

Thomas J. Chemmanur

Boston College - Carroll School of Management

Elena Loutskina

University of Virginia - Darden School of Business

Date Written: September 2006

Abstract

We empirically distinguish between three possible roles of venture backing in IPOs: certification, where venture-backed IPOs are priced closer to intrinsic firm value than non-venture backed IPOs due to venture capitalists' concern for their reputation; screening and monitoring, where VCs are able to either select better quality firms to back (screening), or help create such higher quality firms by adding value to them (monitoring) in the pre-IPO stage; and market power, where venture capitalists attract a greater number and higher quality of market participants such as underwriters, institutional investors, and analysts to an IPO, thus obtaining a higher valuation for the IPOs of firms backed by them. We argue that IPO underpricing is not the most appropriate measure to evaluate the role of venture backing in IPOs. Instead, we compare four sets of more direct measures between VC backed and non-VC backed (and between high-reputation VC backed and low-reputation VC backed) IPOs. The evidence strongly rejects the certification hypothesis, while finding considerable support for the market power hypothesis and some support for the screening and monitoring hypothesis. We find that venture capitalists attract higher quality market participants to the IPOs of firms backed by them, thus increasing the heterogeneity in investor beliefs about these firms, resulting in higher valuations for the equity of these firms (both in the IPO and in the secondary market immediately following the IPO).

Keywords: venture capital, certification, screening, monitoring, market power

JEL Classification: G24, G23

Suggested Citation

Chemmanur, Thomas J. and Loutskina, Elena, The Role of Venture Capital Backing in Initial Public Offerings: Certification, Screening, or Market Power? (September 2006). EFA 2005 Moscow Meetings Paper. Available at SSRN: https://ssrn.com/abstract=604882 or http://dx.doi.org/10.2139/ssrn.604882

Thomas Chemmanur (Contact Author)

Boston College - Carroll School of Management ( email )

Finance Department, 436 Fulton Hall
Carroll School of Management, Boston College
Chestnut Hill, MA 02467-3808
United States
617-552-3980 (Phone)
617-552-0431 (Fax)

HOME PAGE: http://https://www2.bc.edu/thomas-chemmanur/

Elena Loutskina

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-243-4031 (Phone)

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