Role of Venture Capitalists in IPO Corporate Governance and Operating Performance
Bouresli, Amani Khaled, Davidson, Wallace N.,, III, Abdulsalam, Fayez A., Quarterly Journal of Business and Economics
The poor after-performance of initial public offerings has attracted considerable research interest. Studies have documented lower long-run stock returns after an offering (Stoll and Curley, 1970; Stern and Borstein, 1985; Ritter, 1991; Jain and Kini, 1994; Loughran and Ritter, 1995; Mikkelson, Partch, and Shah, 1997). Ritter (1991), for example, finds that IPO firms significantly underperformed a set of non-IPO firms for up to five years after going public.
Venture capital firms often support companies that later go public in the IPO market. Barry, Muscarella, Peavy, and Vetsuypens (1990) document that venture capital-backed IPOs do not suffer as much from mispricing as do other IPOs. Venture capital firms serve as active monitors, providing new firm managers with not only capital but also expertise and guidance. They conclude that venture capitalists play an important role in both shaping and governing new companies.
We examine the role of venture capitalists in governance of the firm pre-and post-IPO. We find that corporate insiders in venture capital-backed IPO firms control a smaller percentage of board seats than in non-venture capital-backed IPOs. As this difference occurs both before and after the IPO date, venture capital firms may take an active role in overseeing companies to which they contribute capital.
The Role of Venture Capital Venture Capital and Board Structure
Hellmann and Puri (1999) define venture capitalists as full-time professional investors who invest and specialize in providing funds to privately held firms. Venture capital participation in the IPO market has grown from 14.3 percent of the IPOs in 1978 to 33.6 percent in 1996 (Gompers and Lerner, 1999).
Venture capital financing is considered one of the major sources of financing for new firms. In most cases, start-up firms do not have access to capital market financing and are often limited to bank loans and syndicated debt. If high-risk start-up firms have substantial tangible opportunities, they may attract venture capital financing. This infusion of funds generally comes with involvement by the venture capitalists in the life of the start-up.
Venture capital firms are typically actively involved in managing and governing the ventures they finance (Sahlman, 1990). Following initial investment, they both formally and informally monitor the startup companies. Formal monitoring would include their participation as members of the board of directors. Barry, Muscarella, Peavy, and Vetsuypens (1990) find that venture capitalists hold about one-third of a company's board seats when they provide the company with funds. Baker and Gompers (2000) note that venture financing tilts the board structure away from insider and affiliated directors toward independent directors. Their main conclusion is that venture capitalists act as active monitors.
Venture capital firms are actively involved in less formal ways, including recruiting, compensation structuring involvement in key corporate decisions such as mergers and acquisitions, and assisting in the IPO process. Gorman and Sahlman (1989), in a venture capital survey paper, find that lead venture investors made an average of 19 visits per year to the company and spent 100 hours in direct contact. Venture capital directors often occupy a high percentage of board seats, implying different governance structures from non-venture capital-backed IPO firms. We expect that there will be smaller proportion of inside directors in venture capital-backed company boards. This leads to our first hypothesis:
HI: Boards of IPO firms with venture capital backing will have proportionately fewer inside and affiliated directors and proportionately more independent outside and venture capital directors.
Ownership Structure of IPO Firms
Jensen and Meckling (1976) emphasize the importance of insider ownership in providing incentives for managers to act in the best interest of shareholders. …