Shareholders' Rights and the Effect of the Origin of Venture Capital Firms on the Underpricing of US IPOs

Abstract

Manuscript Type: Empirical Research Question/Issue: This paper examines whether firm performance at initial public offerings (IPO) is differentially affected by the origin of Venture Capital (VC) firms. Empirical investigations consider both the anti-director index and the anti-self dealing index of the country of origin of a specific VC firm as indicators for its level of legal protection of shareholders' rights. Research Findings/Insights: We find that underpricing of US IPOs is negatively related to the rating of the legal protection rights of VC firms within the VC syndicate of an IPO firm, and the effect is more significant in the subsample of IPOs involving foreign VC firms. There is also evidence of a complementary role played by the legal protection rights of foreign VCs and board independence of IPO firms in reducing underpricing. Further robustness tests confirm empirical findings controlling for the selection bias of IPO firms by foreign VCs, and using the effect of the protection rights of the country of origin of the lead, largest, board member, or oldest, i.e., most experienced, VC firm. There is also evidence of a positive but marginally significant effect of the legal protection rights of VC firms on the long-term performance of their portfolio companies. Theoretical/Academic Implications: Our paper suggests that the institutional framework and national legal differences should matter in considering the effect of VC firms on IPO performance. We find strong support for the institutional perspective whereby institutional predictions were largely supported. Our results also expand on prior research on VC syndication and show that in addition to VC monitoring, the shareholders' protection rights of the country of origin of foreign VC syndicate members would signal the quality of portfolio companies at IPO. Moreover, the complementary role between the legal protection rights of the country of origin of foreign VCs and board independence indicates that firm performance is the outcome of complex mechanisms involving both firm and country-level settings. Practitioner/Policy Implications: Evidence on the association between IPO performance and the origin of VC firms suggests that policy-makers and practitioners should view legal protection of shareholders' rights as a global issue. Since VC investments are valuable for the development of small and medium-size enterprises, our results should contribute to our understanding of cross-border partnering and the quality of partners within the VC industry.