Impact of Venture Capital on Board Composition and Ownership Structure of Companies: An Empirical Study

Article excerpt

This study investigates the role of venture capital (VC) on the board composition and ownership structure of companies making Initial Public Offerings (IPOs) on the Taiwan Stock Market between 2001 and 2003. The study compared the board composition and ownership structure of VC-backed and non VC-backed firms in the Information Technology sector. Results of the study suggest that VC firms focus their investments by providing intensive monitoring service, and allow or enable greater independence with regard to board composition and ownership structure. From these results it is argued that investment by venture capitalists is related to a more independent governance structure and a higher degree of information transparency.

1. Introduction

The Organization for Economic Cooperation and Development (OECD) published a report in 2002, analyzing the 'development status' of Venture Capital (VC) in the United States, Britain, Japan, Germany, and France. The report showed that, based on the ratio of VC investment to Gross Domestic Product, the development status of VC is related to the quality of governance and degree of economic control in the companies in which they invest their capital. Bouresli et al. (2002) and Baker and Gompers (2003) argue that the intervention of VC influences board composition and ownership of the invested company and leads to more independent company governance mechanisms. These studies suggest that differences in board governance and structure between VC-backed and non-VC-backed companies may be attributed to the actual 'presence' of venture capital. This study investigates the attitudes and preferences of venture capitalists (the owners of the VC firms) on the most suitable form of governance in the companies in which they have invested to find out what kind of role venture capitalists play in the formation of company governance.

As VC investment has mainly been in the information technology electronics industry in Taiwan over the last few years, this research will use firms from this industry to examine the influence of VC on the governance, composition of the board of directors and ownership structure of the invested companies. Barry et al. (1990) suggest that VC plays an important role in IPOs. Rosentein, Bruno, Bygrave & Taylor (1993) found that while there is no difference in the perceived value of contributions from directors and supervisors in VC or non VC-backed companies, those backed by the top 20VCs are an exception. Rosentein et al (1993) found that that these directors and supervisors provide higher perceived value than others in this situation. Van den Berghe and Levrau (2002) also investigated the 'aggressive' role that VC plays in the invested companies, especially through special development contracts and detailed monitoring mechanisms with regard to the governance of these companies.

Baker and Gompers (2003) found that boards of directors of IPO's that received funds from VC funds are different in a variety of ways from boards of directors of IPO's that did not receive such funds; specifically, that inside directors and directors from financial institutions, legal firms and accountancy practices have fewer seats on boards of directors of companies, but that there are more independent outside directors in firms that receive VC funds, compared to firms that do not receive funds from this source. These researchers argue that as the major shareholder of an IPO, VC investment is relevant to the governance of independent companies.

2. Research Methodology

2.1. Hypotheses

It is widely believed that, as directors, venture capitalists typically have a monitoring function. Companies- and their boards of directors- that receive VC investment are often 'better protected' if the benefits that accrue to the venture capitalists are about the same as those that are received by stockholders. In addition to offering capital, VCs also monitor operations by serving as directors, by holding supervisory positions, by providing consultation services and by playing an active role in the governance of the invested company. …