Management Quality, Venture Capital Backing, and Initial Public Offerings

Abstract

In this paper we make use of hand-collected data on the quality and reputation of the management teams of a large sample of 3,240 entrepreneurial firms going public during 1993-2004 to conduct the first large-sample study of the relationship between venture capital (VC) backing and management quality and the effect of these two variables on a firm’s IPO characteristics and valuation, post-IPO financial and investment policies, and post-IPO operating performance. We hypothesize that VC-backing positively affects the quality of a firm’s management team, and that both management quality and VC-backing play a certifying role in conveying a firm’s intrinsic value to the IPO market, reducing the information asymmetry faced by it. Our empirical findings are broadly consistent with the above hypotheses, and can be summarized as follows. First, VC-backed firms are associated with higher management quality compared to non-VC-backed firms. Second, both management quality and VC-backing have a positive effect on a firm’s IPO underwriter reputation, offer size, post-IPO analyst coverage, and post-IPO institutional equity holdings; and a negative effect on its costs of going public. Third, management quality and VC-backing also have a positive effect on firm valuation, both in the IPO and in the immediate secondary market. Fourth, management quality is associated with lower post-IPO leverage ratios, and both management quality and VC-backing are associated with larger post-IPO investment levels, as well as larger values of post-IPO acquisitions. Finally, both VC-backing and management quality are positively related to changes in a firm’s post-IPO operating performance. While VC-backing and management quality act as substitutes in their effect on a firm’s IPO characteristics, they act as complements in their effect on a firm’s IPO valuation, post-IPO financial and investment policies, and post-IPO operating performance.