Venture Capital Financing and the Informativeness of Earnings

Abstract

Do venture capital backed firms efficiently transform from closely held private ventures to public corporations? Are there long-term costs to obtaining venture capital financing? We explore the hypothesis, formally derived in the paper, that venture capital backed firms do not efficiently transform to the corporate structure of public firms and have difficulties publicly communicating with arm's length investors. Our results are three fold. First, we find that, on average, reported accounting earnings are less informative for venture capital backed firms. Second, the informativeness of reported earnings is a decreasing function of venture capitalists' ownership of firm equity and a decreasing function of venture capitalists' board representation. Third, stock prices of venture capital backed firms reflect future earnings to a lesser extent relative to non-venture capital backed firms. Our findings support the hypothesis that venture capitalists manage the flow of public information to capital markets and preserve short term interests arising from specific investment and ownership horizons. This evidence suggests that the benefits of receiving venture capital financing are not without costs.

Keywords: Venture capital, earnings informativeness, ownership structure, investment horizon

JEL Classification: M41, G32, G14