Venture capitalists and assurance services on initial public offerings

Abstract

We investigate the effects of venture capital ownership on the demand for auditor reputation, the supply of assurance services, and the quality of financial reporting in the market for new issues. Extensive research exists on the relation between auditing and ownership, however, limited research exists on the relation between auditing and venture capital ownership, a form of ownership characterized as activist and that goes beyond the simple provision of capital. We find that venture capital ownership increases the demand for auditor reputation and that auditors provide a higher level of assurance service to a venture-capital-backed IPO. We also find that the presence of a venture capitalist is associated with lower financial reporting quality, however, this effect is largely offset when a high reputation auditor is also on the IPO. Our evidence is consistent with the argument that venture capitalists on the IPO influence the choice and the extent of auditing to communicate information to investors in a manner that maximizes venture capitalists’ returns for their portfolio fund.