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How useful is venture capital prestige? Evidence from IPO survivability

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Abstract

This study examines the effect of venture capitalist (VC) prestige on the post-issue survivability of IPOs and how VC characteristics influence the effect. We find that IPOs backed by prestigious VCs are less likely to delist for performance failure and have longer listing duration relative to those without VC backing; however, IPOs backed by ordinary VCs are as likely to delist as IPOs without VC backing. The finding is robust for Internet and high-tech firms. We further examine heterogeneous VC characteristics and find that the ability of prestigious VCs to improve IPO survival is a function of their investment experience and managerial ability. VC prestige characterized by industry specialization and syndication networks is not related to IPO survival. Overall, the results suggest that the VC characteristics that produce prestige, rather than the prestige itself, drive the long-term survival of IPOs.

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Notes

  1. We consider two dimensions of IPO survival: the probability of delisting for performance failure and the life duration of IPO issuers.

  2. In our formal empirical analysis, we focus on four VC characteristics through which prestigious VCs can affect the long-term post-IPO survivability of the companies in which they invest. However, we cannot rule out the possibility that VC prestige affects IPOs’ survival via other heterogeneous VC characteristics. For example, relative to traditional VCs, corporate VCs are more skilled in selecting ventures based on their in-depth industry and technology expertise; they have lower due diligence costs and are better at providing complementary resources. Therefore, corporate VCs may select ventures better and add more value (Chesbrough 2000; Dushnitsky and Lenox 2005). In addition, VCs often specialize in a specific stage of company development. Sahlman (1990), for example, indicates that “some will invest only in early-stage deals, whereas others concentrate on later-stage financing.” When a VC displays talents in a particular stage, it will most likely manage a portfolio better by focusing on that specific area. Given the limitations of our analysis, we are not able to analyze all the VC characteristics through which prestigious VCs affect IPO survival. However, at a very minimum, our empirical study presents some very interesting correlations between VC characteristics and their investment outcomes, which will potentially inspire future researchers to investigate the underlying relationships in greater depth. We particularly appreciate an anonymous referee, who provided very insightful comments on the issues discussed in this footnote.

  3. The authors report that the difference in performance is significant when returns are computed on an equal-weighted basis. Their results indicate that the underperformance (first identified by Ritter 1991) is not unique to firms issuing equity but is a small, low book-to-market effect. In this paper, we examine the delisting risk of IPO stocks from all major U.S. exchanges due to operating failure as one alternative measure of long-run performance, which avoids the controversies surrounding appropriate risk benchmarks.

  4. In this paper, we use a five-year tracking window to identify the subsequent survival profile of IPOs. The five-year tracking window is a subjective choice but appropriate for two reasons. First, previous studies (e.g., Jain and Kini 2000; Li et al. 2008) often use 5 years as a tracking window for post-IPO long-run performance. Second, 5 years is generally long enough to evaluate an IPO firm. Because of the five-year tracking window, our sample period ends in 2003. To test the robustness of our inferences for the newest IPOs, we also set the tracking window at three post-issue years and thus expand the sample period to 2005. The empirical results are qualitatively and quantitatively similar to those reported later. For brevity, the results of this sensitivity test are not reported here but are available upon request from the author.

  5. For robustness, we also use the top one-fifth as an alternative cutoff point. The results are qualitatively unchanged.

  6. To evaluate whether our results are sensitive to the post-issue tracking period, we analyze three different definitions of the delisting dummy. Thus, we set the binary delisting dummy equal to 1 if the firm fails within 3, 4, or 5 years of the IPO, and 0 otherwise.

  7. We identify investment bank reputation by the updated nine-point measure of Carter et al. (1998). The measures are from Professor Jay Ritter’s website at http://bear.cba.ufl.edu/ritter/rank.xls. These ratings appear in Loughran and Ritter (2004) and are adaptations of the ratings that first appeared in Carter and Manaster (1990). The measure ranges from 1 (low quality) to 9 (high quality).

  8. Z-score is defined as 1.2 × (net working capital/total assets) + 1.4 × (retained earnings/total assets) + 3.3 × (earnings before interest and taxes/total assets) + 0.6 × (market value of equity/book value of liabilities) + 1.0 × (sales/total assets).

  9. We use the SDC for identification purposes. The high-tech industry covers biotechnology, chemicals, computers, pharmaceuticals, communications, electronics, and medical equipment, among other businesses. In addition, no standard SIC code or other official classification system exists to identify Internet firms. We match our sample against a list of Internet-related offerings used by Loughran and Ritter (2004), who obtained their data by merging and amending the Internet identifications of Thomson Financial Securities Data, Dealogic, and IPOmonitor.com.

  10. For brevity, we pool the results for Internet and high-tech firms. The results for separate Internet, high-tech, and other firms are qualitatively similar.

  11. For brevity, we only report the logistic regression results of delisting within five post-issue years; the results for three- and four-year windows are qualitatively the same (not reported).

  12. Unlike the number of successful IPO firms, the IPO rate avoids the strong bias toward elder VC firms because it adjusts for the number of firms a VC has previously invested.

  13. An anonymous referee provided very insightful comments on the issues discussed in this paragraph, for which we are particularly thankful.

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Acknowledgments

The authors gratefully acknowledge Emilio Venezian, Robert Faff, Gili Yen, Huiming Chung, and Taiyuan Chen for providing constructive comments on earlier drafts of this paper.

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  1. Department of Accounting and Information Technology, National Chung Cheng University, Chia-Yi, Taiwan, ROC

    Ting-Kai Chou

  2. Department of Accounting, College of Management, Yuan Ze University, 135 Yuan-Tung Road, Chung-Li, Taoyuan, 32003, Taiwan, ROC

    Jia-Chi Cheng

  3. Department of Accountancy, National Cheng Kung University, Tainan, Taiwan, ROC

    Chin-Chen Chien

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Chou, TK., Cheng, JC. & Chien, CC. How useful is venture capital prestige? Evidence from IPO survivability. Small Bus Econ 40, 843–863 (2013). https://doi.org/10.1007/s11187-011-9389-5

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