Does corporate governance really matter in the public venture capital industry?

Abstract

Publicly traded venture capital (VC) funds invest in high risk startup companies. In the United States, VC funds report their equity investments using Fair Value Accounting (ASR 118). Since there is no open market for shares of these startup companies, fair value estimates are determined by management, and are therefore subject to managerial discretion. We believe that these unique characteristics of VC funds make it the ideal laboratory to examine the importance of corporate governance to investors. We first examine whether good corporate governance, as represented by our governance index unique to this industry, PGOV, is correlated with higher fair values of equity investments. We find that it is. Furthermore, due to the unique ownership makeup of these firms in that they are largely owned by highly sophisticated investors such as institutions, and by insiders, we study the effects of the presence of insiders and institutional owners on firm fair value. We find that the presence of institutional investors seems to enhance firm fair value, while the presence of insiders detracts from it. Second, we study whether the market values corporate governance mechanisms in this unique industry above that of fair value. We find that it does not. When firms are performing well, the market does not react to increases in our corporate governance index, PGOV. This work contributes to the venture capital literature and yields important evidence regarding the market’s perception of the value of corporate governance in an industry with highly sophisticated institutional and inside investors.