Academic journal article International Journal of Business

Active Financial Intermediation and Market Efficiency: The Case of Fast-Growing Firms Financed by Venture Capitalists

Academic journal article International Journal of Business

Active Financial Intermediation and Market Efficiency: The Case of Fast-Growing Firms Financed by Venture Capitalists

Article excerpt

I. INTRODUCTION

In recent years, there has been some debate between financial economists on the difficulties experienced by fast-growing companies to communicate their quality to financial backers (Mc Kie-Masson, 1990; and Rajan and Zingales, 1995). The literature indicates that the nature of high-tech company assets implies risk levels for creditors that they refuse to assume or that they are only prepared to assume at excessive cost. Such companies favour equity financing, which means opening up the company's capital. This approach implies a change in the company's capital structure and control, thereby generating agency costs. In this situation, the models developed by Jensen and Meckling (1976), Leland and Pyle (1977) and Rock (1986) lead us to predict a decline in profitability when such changes in company control take place. This has also been noted empirically in the case of initial public offerings (IPO) by Jain et al. (1994), Mikkelson et al. (1997), Jain and Kini (1999), Pagano et al. (1998), and Coakley et al. (2004). Informational asymmetries between companies and the market encourage non-growth companies to opportunistically adopt behaviour that mimics fast-growing companies so as to raise capital on the stock market. Anticipating this strategy, the market demands information to manage the problem of reverse selection and this results in costs which grow with informational asymmetry. The signalling models underline the fact that undervaluation is a strategy used by shareholders in fast-growing companies to help stand out from non-growth companies. Allen and Faulhaber (1989), Grinblatt and Hwang (1989) and Renneboog et al. (2007) theoretically modelled the undervaluation of an initial public offering as the cost of the search for information, borne by investors to enable them to value the company. More specifically, these authors consider that stock market listings are achieved by initially offering a small proportion of the capital at an undervalued price. A second issue then completes the opening of the capital at the company's market price. This process immediately sanctions non-growth companies while satisfying the shareholders of fast-growing companies.

Research to date has suggested that problems experienced by organisations in communicating information about their growth opportunities and changes to their control structure impacts on the company's IPO valuation. Nonetheless, while company-specific factors generate informational differentials between the company and the financial markets, the theoretical and empirical work by Chemmanur and Fulghieri (1994) and Jain and Kini (1999) have highlighted the contribution of investment banks in the production of screening and monitoring information. This contribution thus partially remedies the lack of information which a company may suffer from.

Within this context, the aim of this study was to ascertain the extent to which information produced by venture capitalists can be considered as an extension of the information produced by the company, modifying the company's IPO valuation. Our findings indicate that the "ROE" (return on equity) and "percentage of voting rights owned by the public" variables are the best indicators of undervaluation, depending on whether a probabilistic or a linear approach is used. We also argue that venture capitalists fulfil an intermediation role of information production by providing expertise and validating information produced by the company. Moreover, it appears that companies financed by active venture capitalists are less undervalued than companies financed by hands-off venture capitalists.

The rest of the paper is organized as follows. Section 2 explores the theoretical bases and the empirical results on which the hypotheses are based. In section 3, we define the sample and methodology, while section 4 examines the firm's characteristics and the information produced by venture capitalists on IPO valuation. …

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