Myth or Reality? The Long-Run Underperformance of Initial Public Offerings: Evidence from Venture and Nonventure Capital-Backed Companies

Abstract

This study addresses the three main issues related to the underperformance of initial public offerings (IPOs), reported in prior studies. Examines whether venture capitalists affect the long-run performance of newly public firms, investigates the effects of using different benchmarks and different methods of measuring performance to gauge the robustness of IPO underperformance, and provides initial evidence on the sources of underperformance. Data--including date of the offering, size of the issue, issue price, number of secondary shares, and the underwriter--were gathered from 934 venture-backed IPOs, for 1972-1992, and 3,407 nonventure-backed IPOs, for 1975-1992. Results show that returns on venture-backed IPOs are significantly greater than returns on nonventure-backed IPOs. In addition, returns on nonventure-backed IPOs are below relevant benchmarks when returns are weighted equally. Differences in performance between the groups and the level of underperformance are reduced once returns are value weighted. It is also shown that underperformance is not unique to firms issuing equity--eliminating IPOs and seasoned equity offerings from size and book-to-market portfolios demonstrates that IPOs perform no worse than similar non-issuing firms. Reexamining the result from prior research on underperformance finds that most comes from small, nonventure-backed IPOs. The performance is similar to that of small, low book-to-market non-issuing firms. Reasons for this category of underperformance need further experimentation. (SFL)