VC backing and IPO performance

Research Paper Title:

“The relationship between venture capital backing and the top management team quality of firms going public and implications for initial public offerings”

Authors:

Thomas Chemmanur (Boston College)
Manish Gupta (University of Nottingham)
Karen Simonyan (Suffolk University)
Hassan Tehranian (Boston College)

Background:

The first objective of this paper is to analyze how VC-backing is related to top management team (TMT) quality of the firms they back at the time of their IPOs. The second objective of this paper is to study how the TMT quality of a firm and VC-backing itself affect the growth in post-IPO operating performance and the IPO valuation of firms going public.

Methodology:

Sample: list of U.S. IPOs covering the twenty year period from 1993 to 2012 from the SDC/Platinum Global New Issues database.
Sample Size: 3903 IPO firms; 2380 VC-backed and 1523 non-VC-backed.
Analytical Approach: Regression analysis and other analytical techniques; IV analyses to establish causality.

Hypothesis:

1. VC-backed firms will have higher quality TMTs at IPO than non-VC-backed firms.

2. TMT quality will have a positive effect on the growth in post-IPO operating performance of firms going public, acting through the ability channel.

3. TMT quality will have a positive effect on a firm's IPO market valuation, acting through either the ability channel or the certification channel, or through both channels.

4. VC-backing will have a positive effect on a firm's IPO market valuation, acting through either the ability channel or the certification channel, or through both channels.

5. TMT quality will be negatively related to the extent of information asymmetry facing firms in the equity market.

6. VC-backing will be negatively related to the extent of information asymmetry facing firms in the equity market.

7. The effect of TMT quality on the growth in post-IPO operating performance will be stronger in VC-backed firms than in non- VC-backed firms.

Results:

All hypotheses are supported by empirical analysis.

1. VC-backed firms will have higher quality top management teams at IPO than non-VC-backed firms.

2. The top management team (TMT) quality of private firms going public will have a positive effect on the growth in post-IPO operating performance of firms going public, acting through the ability channel.

3. Private firms going public with higher top management teams will be characterized by a lower extent of information asymmetry in the equity market after their IPOs. The researchers refer to this as the "certification channel."

4. Venture backed private firms going public will also be characterized by a lower extent of information asymmetry in the equity market after their IPOs.

5. TMT quality will have a positive effect on a firm's IPO market valuation, acting through either the ability channel or the certification channel, or through both channels.

6. VC-backing will also have a positive effect on a firm's IPO market valuation, acting through either the ability channel or the certification channel, or through both channels.

7. The effect of TMT quality on the growth in post-IPO operating performance will be stronger in VC-backed firms than in non- VC-backed firms.

Conclusion:

In this paper, the researchers showed that TMT quality is an important variable affecting the success of private firms' IPOs. In particular, they demonstrated a positive association between VC-backing and TMT quality in a large sample of private firms going public. Further, the authors showed that TMT quality at IPO and VC-backing each have a positive effect on two important IPO variables: equity valuation at IPO and the growth in a firm's post-IPO operating performance. Finally, this study showed that, on average, VC-backing and TMT quality act as complements in affecting the growth in private firms' post-IPO operating performance.