Does Managerial Optimism Lead to Long-Run Underperformance? Evidence from Venture Capital-Backed IPOs

Abstract

In a sample of 776 venture capital-backed IPOs, I find that IPOs with more optimistic managers underperform IPOs with less optimistic managers in the long-run. Moreover, the IPOs of the most optimistic managers underperform in the long-run when compared to a benchmark portfolio, while the IPOs of the least optimistic manager do not. In particular, IPOs with more optimistic managers underperform IPOs with less optimistic managers by about 45% (40%) on an equal-weighted (value-weighted) basis in the 5-year period following the offer. Indeed, even relative to their style matched portfolio, the firms of the most optimistic managers underperform by about 43% (72%) on an equal-weighted (value-weighted) basis. These results are confirmed using a calendar-time factor-adjusted portfolio approach. Is the long-run underperformance a result of overinvestment or underinvestment? The evidence suggests that it is driven by underinvestment. In fact, the investment of more optimistic managers is significantly lower than for less optimistic managers for 4 of the 5 fiscal years after the offer. These results are robust to industry-adjusting and the inclusion of additional explanatory variables including cash holdings. I also find some evidence that investment is sensitive to cash flows, with high cash flow IPOs mitigating a portion of the underinvestment in some of the years following the offer. Finally, managerial optimism is significantly and positively associated to first-day returns, suggesting more optimistic managers are more prone to using to the middle of the file price range as a reference point from which they anchor.