Grandstanding, certification and the underpricing of venture capital backed IPOs

Abstract

We examine the role of venture capital backing in the underpricing of IPOs. Controlling for endogeneity in the receipt of venture funding, we find that venture capital backed IPOs experience larger first-day returns than comparable non-venture backed IPOs. Between 1980 and 2000, the average return difference ranges from 5.01 percentage points to 10.32 percentage points. This return difference is particularly pronounced in the “bubble” period of 1999–2000. Consistent with the grandstanding hypothesis proposed by Gompers (J. Financial Econ. 42 (1996) 133), we find that higher underpricing leads to larger future flows of capital into venture capital funds, particularly after 1996. Cross-sectionally, the effect of underpricing is attenuated for younger venture capital firms and those that have previously conducted fewer IPOs.