Initial public offerings and insider participation: The role of venture
capitalists and corporate partners in the IPO process
Hans Jeppsson*
Institute for Innovation and Entrepreneurship, and Industrial and Financial Management & Logistics
University of Gothenburg, School of Business, Economics and Law
Abstract
Past empirical research has shown that subscription precommitments by large blockholders
can help certify firm value in new equity issues and influence the subscription decisions of
small, relatively uninformed investors. We propose that subscription precommitments and
insider buying by preexisting investors during the IPO acts as a bonding mechanism for
credible certification of the IPO issue price and provides a direct proxy for ex ante uncertainty
about an IPO’s valuation. This paper examines the association between insider participation
and IPO underpricing, price revision, and post-IPO stock return volatility. We find that insider
participation is unassociated with IPO underpricing, but when disentangling venture
capitalists and corporate partners, the latter is associated with lower IPO underpricing. On the
contrary, venture capitalist participation is negatively associated with price revisions and
remains robust when examining changes in venture capitalist participation in the
bookbuilding period. A detailed analysis of ownership data documents in many instances a
continuing role for venture capitalists as shareholders in the years after going public, which is
consistent with the certification hypothesis. This paper sheds light on the role of venture
capitalists and corporate partners in the initial public offering process and contrasts past
research considering IPOs as exit events.
JEL-classification:
Keywords:
*
G32
Initial public offering (IPO); Insider buying; Venture capital; Corporate
partners; Certification; Subscription precommitments; Underpricing
Department of Business Administration, School of Business, Economics and Law at the University of
Gothenburg. P.O. Box 610, SE-40530 Gothenburg, Sweden. Tel.: +46 31 786 1463. Email:
hans.jeppsson@handels.gu.se. This paper was written while the author was a visiting research scholar at UC
Berkeley, and he is appreciative of the opportunity given by the Haas School of Business at UC Berkeley. An
earlier version of this paper was presented at the Innovation and Entrepreneurship in Health Care & Life Sciences
workshop in Gothenburg, Sweden, in December 2014. Financial support was provided by Broman Foundation.
Any errors and omissions are the authors.
1. Introduction
On February 5-6, 2014, four venture-backed biotechnology companies successfully went
public on the Nasdaq Stock Market. They completed initial public offerings within their
expected price ranges and two at the top of price ranges. Not only that, three of the companies
increased the size of their offerings because of demand and three of them had a positive
aftermarket performance. The successful public offerings brought considerable media interest
about the prospects for profitable exits for venture-backed companies. However, the firms that
went public did so with a significant participation of preexisting venture capital and corporate
investors. According to the IPO prospectuses preexisting shareholders had made subscription
precommitments to purchase collectively 14.3 percent of the total IPO proceeds representing
$36 million in total. A review of the class of venture-backed biotechnology firms that went
public in the period 2003-2014 raised $12.62 billion in proceeds, in which preexisting
investors made precommitments to purchase 17 percent or $2.14 billion.
Several studies provide evidence that the opportunity cost of going public is directly related to
the level of information asymmetry either between informed and uninformed investors (e.g.
Rock, 1986) or between corporate insiders and public investors (Booth and Smith, 1986;
Megginson and Weiss, 1991). Past empirical research has find evidence that firms can send
signals to investors to indicate firm quality and reduce the degree of underpricing through
third-party certification, such as hire a higher-quality underwriter (Booth and Smith, 1986;
Carter and Manaster, 1990; Michaely and Shaw, 1994; Carter et al., 1998)1, or a reputable
auditor (Beatty, 1989; Titman and Trueman, 1986) can mitigate the information asymmetry
through certification, thereby reducing the opportunity cost. Similar to underwriters and
auditors, corporate partners can also be viewed as performing a similar validating function
(Nicholson et al., 2005). In contrast to certification by third-parties, the credibility of venture
capitalists in certifying an IPO is conveyed both through their investment in reputational and
monetary capital at stake (Dolvin and Pyles, 2006; Krishnan et al., 2011; Megginson and
Weiss, 1991). Lin (1996) finds evidence for the certification role of large block shareholders
in IPOs and documents a negative association between lead venture capitalist pre-IPO
shareholding and IPO underpricing. While reputation is an important factor for venture
capitalists who intend to be active long-term players in the financial market (e.g. Krishnan et
1
In fact, research suggests mixed results on the association between initial returns and the reputation of the
underwriter. During the 1980s, initial returns were negatively related to underwriter reputation (Carter and
Manaster, 1990; Carter et al., 1998). However, during the 1990s, there was a positive relationship between initial
returns and the reputation of the underwriter (Beatty and Welch, 1996; Loughran and Ritter, 2004).
-1-
al., 2011), we argue that a more direct proxy for certification is the commitment by
preexisting investors to participate in the IPO. Subscription precommitments by preexisting
investors to purchase additional shares in the IPO may convey a significant signaling effect to
outside investors. Eckbo and Masulis (1992) argue that subscription precommitments by large
blockholders, which companies typically disclose in connection with seasoned equity
offerings, such as rights offerings, are likely to influence the subscription decisions of small,
relatively uninformed shareholders. Cronqvist and Nilsson (2005) suggest that subscription
precommitments can act as a substitute for certification by an underwriter or a private
placement investor when raising follow-on offerings. This paper examines whether
subscription precommitments by preexisting investors, such as venture capitalists and
corporate partners, can help certify the IPO price and the association with underpricing, price
revision and post-IPO stock return volatility.
We focus on venture-backed firms in the biotechnology industry for several reasons. First,
information asymmetry is particularly evident in R&D-intensive industries such as the hightechnology sector (Himmelberg and Petersen, 1994) and particularly the biotechnology
industry (Lerner et al., 2003; Hall, 2002)2. Hall and Lerner (2009) argue that the marketplace
for financing the development of R&D may look like the ‘lemons’ market, as suggested by
Akerlof (1970, 2002). In the most extreme case, the market for financing R&D projects may
completely disappear if the level of information asymmetry is too high. Second, venturebacked biotechnology companies represent by nearly 30 percent of all venture-backed IPOs
the far largest category over the period 2003-2013. Third, the close interrelation between
biotechnology-pharmaceutical firms provides an opportunity to evaluate insider participation
not only by venture capitalists, but also by corporate partners.
2
Several factors contribute to the information asymmetry in the biotechnology industry. First, managers in
R&D-intensive industries generally know considerably more than outsiders do about the specification of
products under development, the likelihood of success, the results of product feasibility tests, and marketing
prospects (Aboody and Lev, 2000). Second, the extent of information asymmetry associated with R&D
investments is larger than that associated with tangible and financial investments due to the relative uniqueness
of R&D (Aboody and Lev, 2000; Titman and Wessels, 1988). R&D projects, such as the development of a new
drug, are often unique to the developing firm. For example, a failure of a drug with a new mechanism of action
to exhibit efficacy in humans is a unique event not shared by other biotechnology or pharmaceutical companies.
Hence, investors generally derive little or no information about the firm’s R&D projects by observing the R&D
performance of other drugs. Third, while financial assets are traded in organized markets, where prices are
observable and convey direct information about values, there are no organized markets for R&D where prices
are available. Fourth, while financial assets are generally marked-to-market and reported on a quarterly basis,
current accounting practice requires firms to immediately expense their significant value-enhancing investments
in R&D, and therefore, it is generally not required that information be provided about the value of R&D. 2 Fifth,
firms are reluctant to disclose firm-specific and proprietary information about the firms’ R&D activities for
competitive reasons (Guo et al., 2004; Bhattacharya and Ritter, 1983).
-2-
Our paper is related to a numerous studies exploring the determinants of the going public
decision, insider participation, the certification role of corporate partners, subscription
precommitments in equity issues as well as the information content of S-1 and 424 filings in
IPOs. Lerner (1994) provides evidence for a sample of biotechnology firms that experienced
venture capitalists are able to time IPOs at market peaks and employ private financings when
equity values are lower, but does not examine selling (or buying) behavior by the venture
capitalists in connection with the IPO. In contrast, Ball et al. (2011) find no support for the
market-timing hypothesis, but find evidence of pseudo-market timing, i.e. venture-backed
issuers react to market or sector run-ups but do not predict downturns. Our focus on insider
buying during the IPO is different from the focus of Lin and Smith (1998), Habib and
Ljungqvist (2001), and, Ljungqvist and Wilhelm (2003), who examine selling decisions by
preexisting investors during the IPOs. Lin and Smith (1998) focuses exclusively on venturebacked IPOs and find that insider reputation play a role in the unwinding of venture capital
investments during IPOs, although most venture capital investors do not sell during the IPO.3
Ljungqvist and Wilhelm (2003) find that underpricing is inversely related to the participation
ratio (defined as the number of secondary shares sold relative to pre-IPO shares outstanding).
Our paper also relates to recent work by Ozmel et al. (2013), who examine alliance- and VC
activity and their impact on exit decisions in venture-backed biotechnology firms. In addition,
our work is also related to the role of subscription precommitments in equity issues. Eckbo
and Masulis (1992) argue that subscription precommitments by large blockholders are likely
to influence the subscription decisions of small, relatively uninformed shareholders. Cronqvist
and Nilsson (2005) suggest that subscription precommitments can act as a substitute for
certification by an underwriter or a private placement investor when raising follow-on
offerings, which further underscore our contention that subscription precommitments play a
strategic role in the firm’s decision to go public. Furthermore, past research on pricing of
initial public offerings typically examine the information contained in the final IPO
prospectus (Form 424), which is typically filed on EDGAR on the day of or a few days
following the IPO. Similar to e.g. Loughran and McDonald (2013), this paper examines the
role of S-1 and subsequent amended filings in the pricing of initial public offerings, which on
average is filed 109 days prior to the IPO.
The analysis of participation by preexisting investors provides several insights. Insider
participation is unassociated with IPO underpricing, but when disentangling insider
3
In their study, the lead investor sells shares in 27 percent of the total of 497 venture-backed IPOs.
-3-
participation into participation by venture capitalists and corporations, respectively, we find
that the participation of corporate partners is negatively associated with underpricing, whereas
there is no association between venture capital participation and IPO underpricing. However,
venture capitalist participation is negatively associated with price revisions, and is also robust
when examining changes in insider participation during the bookbuilding period. This is also
illustrated in our Tobit regression, where we show that venture capital investors are likely to
increase the number of shares when offer prices are downward revised. This also provides a
rational explanation as venture capitalists bring companies public as part of a venture capital
exit strategy (Gladstone, 1989) given the finite time horizon of venture capital funds. The
quality signal that venture capitalists provide through their reputational and large preexisting
shareholdings may suggest that the quality signal of subscription precommitments may
already be incorporated into the offer price.
Participation of preexisting investors is unable to decrease the stock return volatility in the
post-IPO period. We show that a high percentage initial return does not necessarily imply a
large percentage opportunity cost to preexisting shareholders. The opportunity cost may also
be justified and seen in light of that the IPO created a market for the shares in a single day.
Finally, we show, consistent with the certification hypothesis, that venture capital investors
retain substantial holdings in the portfolio firms as a bonding mechanism for credible
certification. A detailed analysis of ownership data documents in many instances a continuing
role for venture capitalists as shareholders in the years after going public.
The remainder of the paper is outlined as follows. Section two provides a theoretical
framework, an overview of prior studies and the research hypotheses. Section three presents
the data. Section four contains the empirical results. Section five provides robustness tests,
and section six concludes.
2. Theory and research hypotheses
2.1 Asymmetric information, initial public offerings and underpricing
Going public represents a significant event in the lifecycle of a new venture. It provides
access to public equity capital and may lower the cost of funding the company’s operations
and investments (Ljungqvist, 2007). It also provides a venue for trading the company’s
shares, enabling its existing shareholders to diversify their investments and to realize their
capital gains from backing the company – an important consideration for venture capitalists
-4-
due to their unique skill and comparative advantage in the guidance of new entrepreneurial
ventures. Among the different exit choices, the initial public offering (IPO) of shares in the
portfolio firms is often regarded as the most essential one in terms of its contribution to a
venture capitalist’s return (Gompers and Lerner, 1999).
Firms going public experience both direct costs associated with compensation paid to
underwriters, as well as indirect costs in the form of underpricing (i.e. money left on the
table). Several studies provide evidence that a primary explanation for the opportunity cost of
going public is directly related to the level of information asymmetry either between informed
and uninformed investors (e.g. Rock, 1986) or between corporate insiders and public
investors (Booth and Smith, 1986; Megginson and Weiss, 1991). As underpricing provides a
real wealth loss because it transfers wealth from existing shareholders to new shareholders,
there are clear incentives to reduce the information asymmetry and the resulting adverse
selection problem (Akerlof, 1970).
Considerable theoretical work has been done on imperfect information and the role of
financial intermediaries that can evaluate and signal to markets the quality of firms (e.g.
Leland and Pyle 1977; Campbell and Kracaw 1980; Chan 1983; Chemmanur 1993; and
Chemmanur and Fulghieri 1994). In past empirical financial research on IPOs, signaling
theory (Spence, 1973) has been used to show that firms can send signals to investors to
indicate firm quality and reduce the degree of underpricing. To provide an effective signaling
mechanism for an equity offering, an issuer can hire the reputation form a third party
specialist. By agreeing to be associated with an offering, prestigious intermediaries “certify”
the quality of the issue and thereby reduce the opportunity cost. This line of research
demonstrates that hiring a prestigious underwriter (Booth and Smith, 1986; Carter and
Manaster, 1990; Michaely and Shaw, 1994; Carter et al., 1998)4, or, a reputable auditor
(Beatty, 1989; Titman and Trueman, 1986) serve as signals in the IPO process. However,
according to the certification model (Beatty and Ritter, 1986), the certification role may be
better performed by venture capitalists because of two main reasons. First, venture capitalists
are generally much more knowledgeable about the issuing firm due to their equity holdings,
often holding several board seats, the active involvement in key personnel and strategic
decisions, meetings with customers and suppliers, and enjoying longer and closer working
4
In fact, research suggests mixed results on the association between initial returns and the reputation of the
underwriter. During the 1980s, initial returns were negatively related to underwriter reputation (Carter and
Manaster, 1990; Carter et al., 1998). However, during the 1990s, there was a positive relationship between initial
returns and the reputation of the underwriter (Beatty and Welch, 1996; Loughran and Ritter, 2004).
-5-
relationship with the management team compared with other financial intermediaries (e.g.
Gorman and Sahlman, 1989; Sahlman, 1990; Barry et al., 1990; Lerner, 1995). Second, the
reputation factor can control possible false certification by venture capitalists (Sahlman,
1990). The credibility of venture capitalists in certifying an IPO is conveyed both through
their investment in reputational and monetary capital at stake (Dolvin and Pyles, 2006;
Krishnan et al., 2011; Megginson and Weiss, 1991). Lin (1996) finds evidence for the
certification role of large block shareholders in IPOs and documents a negative association
between lead venture capitalist pre-IPO shareholding and IPO underpricing. Barry et al.
(1990) find that the presence of experienced venture capitalists on the board of directors
lowers IPO underpricing. Megginson and Weiss (1991) report that VC-backed companies
experience lower underpricing, higher net proceeds and higher institutional holding compared
to non VC-backed companies. Furthermore, venture capitalists are concerned about their
reputation if they seek to be active long-term players in the financial market.5 Krishnan et al.
(2011) show that VC reputation, measured by the past market share of VC-backed IPOs, is
positively associated with long-run firm performance measures.
Similar to underwriters and auditors, corporate partners can also be viewed as performing a
similar validating function. For example, Nicholson et al. (2005) argue that if investors have
less information than pharmaceutical firms regarding the likely success of a biotech firm’s
products and the quality of its science and management, then by doing a deal with a
pharmaceutical firm, a biotech firm can signal its quality to financial markets. Ozmel et al.
(2013) find that both alliance and VC activity raise the hazard of going public. However, they
find no association between IPO underpricing and alliance activity, measured as the total
number of alliances over the last five years, which makes them to conclude that at least part of
the quality signal that the alliances provide may already be incorporated into the offer price.
2.2 Initial public offerings and insider selling
Past empirical research has focused on venture capitalists’ timing of going public (e.g.
Gompers, 1996; Lerner, 1994; Ball et al., 2011) and selling decisions by venture capitalists
during the IPOs of their portfolio companies (e.g. Lin and Smith, 1998; Ljungqvist and
Wilhelm, 2003). Lerner (1994) provides evidence that experienced venture capitalists are able
to time IPOs at market peaks and employ private financings when equity values are lower, but
5
For a detailed discussion on VC reputation, see e.g. Nahata (2008).
-6-
does not examine selling behavior by the venture capitalists in connection with the IPO. A
venture capitalist may want to sell during the IPO of a portfolio company either because
alternative opportunities offer higher risk-adjusted returns, or because of a belief that the
shares would be overvalued by the market (Lin and Smith, 1998). Rational outside investors
recognize the potential for overvaluation and react negatively to the venture capitalist’s
decision to sell. Since outside investors are unable to distinguish between overvaluation and
other motives for selling, the IPO issue price must be low enough so that, on average, returns
to outside investors are at least normal (Rock, 1986). In the most extreme case it could lead to
market failure of the type described by Akerlof (1970), i.e. the IPO market may disappear
entirely, unless the information asymmetry can be reduced or mitigated. Since venture
capitalists are recurrent players in the IPO market there are strong a priori reasons to believe,
given the significant cost associated with false certification, that they have an incentive to
establish/or maintain their reputation in order to retain access to the IPO market (Bygrave and
Stein, 1989). Lin and Smith (1998) focuses exclusively on venture-backed IPOs and find that
insider reputation play a role in the unwinding of venture capital investments during IPOs,
although most venture capital investors do not sell during the IPO. They document that
insider selling by the lead venture capitalist only occurs in 27 percent of the IPOs. Ljungqvist
and Wilhelm (2003) find that underpricing is inversely related to the participation ratio
(defined as the number of secondary shares sold relative to pre-IPO shares outstanding).
The existing literature on venture capital exits has mainly treated the IPO itself as an exit
event (See, e.g., Cumming, 2008). However, venture capitalists (VCs) infrequently sell their
shares at the time of the IPO (Barry et al., 1990; Gompers and Lerner, 1998). Selling is more
likely for issues of companies with established performance records, whereas the venturebacked IPO universe is intensive in firms with negative trailing earnings and few assets-inplace (Loughran and McDonald, 2013).
2.3 Initial public offerings, subscription precommitments and insider participation
In seasoned equity offerings, such as rights offerings, it is common to see subscription
precommitments by large shareholders. Eckbo and Masulis (1992) and Singh (1997) report
that companies typically obtain substantial levels of subscription precommitments from large
shareholders before choosing the uninsured rights offering method compared to standby
underwritten rights. Cronqvist and Nilsson (2005) and Balachandran et al. (2008) find that
-7-
subscription precommitments is likely to impact the expected take-up levels in rights
offerings and play a role in the firms’ decision to choose between different equity-selling
mechanisms. For example, Cronqvist and Nilsson (2005) find evidence that family-owned
firms are significantly more likely to issue low-voting shares in rights offerings when the
family has not provided a subscription precommitment. Subscription precommitments may
also have a signaling effect to outside investors. Eckbo and Masulis (1992) argue that
subscription precommitments by large blockholders are likely to influence the subscription
decisions of small, relatively uninformed shareholders. They also document that firms with
more concentrated ownership are more likely to obtain subscription precommitments.
Cronqvist and Nilsson (2005) suggest that subscription precommitments can act as a
substitute for certification by an underwriter or a private placement investor when raising
follow-on offerings.
The decision by preexisting investors to make precommitments to participate in the initial
public offering is consistent with the certification hypothesis by Barry et al. (1990) and
Megginson and Weiss (1991). Barry et al. (1990) suggest that retention of ownership provides
both a signal of value and an ongoing commitment to monitor.6 Megginson and Weiss (1991)
argue that venture capital investors certify the IPO issue price by maintaining ownership in
the company.
We propose that the participation of preexisting investors in the IPO act as a bonding
mechanism for credible certification and provides a direct proxy for ex ante uncertainty about
an IPO’s valuation and a certification of the IPO issue price (i.e. a highly observable signal).
Our framework yields several testable empirical predictions:
1a. The degree of underpricing of IPOs is on average lower in IPOs where preexisting
investors buy shares.
1b. The degree of underpricing of IPOs is on average lower in IPOs where venture
capitalists buy shares.
1c. The degree of underpricing of IPOs is on average lower in IPOs where reputable
venture capitalists buy shares.
6
To examine the commitment to ongoing monitoring, they examine holdings approximately 1 year after the IPO.
They find that holdings 1 year later have declined by 28% and that the number of seats on the board remains
high. From these results they infer that venture capitalists are long-run investors who commit to provide ongoing
monitoring.
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1d. The degree of underpricing of IPOs is on average lower in IPOs where corporate
partners buy shares.
2. Offer price revisions are on average lower where preexisting investors buy shares.
3. The post-IPO stock return volatility is on average lower in IPOs where preexisting
investors buy shares.
4. Venture capital investors participating in the IPOs are on average associated with
longer share ownership holding periods.
The first implication follow from the objective from the information asymmetry problem
between corporate insiders of issuing firms and outside investors and concerns the association
between venture capitalist/corporate participation (and reputation) and underpricing. The
second implication concerns the certification role of preexisting investors buying shares in the
IPO and the associations with stock price revisions as well as stock return volatility in the
subsequent period following the IPO. The fourth implication follows from the objective that
ownership positions, long-term involvement and continued monitoring for venture capital
investors of their portfolio firms follows from the signaling of purchasing additional shares in
connection of the IPO.
3. Data
3.1 Data and sample
To test our predictions, we analyze a sample of private venture capital-backed biotechnology
companies that went public during the period 2003 to 2014. Although our primary period of
analysis starts in 2003, we begin our sample period in 2000 for purposes of determining our
measure of venture capital reputation, which is based on a venture capitalist’s dollar market
share of all venture-backed IPOs in the preceding 3 calendar years7. The sample of
biotechnology firms was selected from the Securities Data Company’s (SDC) New Issues
Database with the following primary SIC industry sector codes: 2833 (Medicinal chemicals
and botanical products), 2834 (Pharmaceutical preparations), 2835 (In vitro and in vivo
diagnostic substances), 2836 (Biological products, except diagnostic substances), and 8731
(Commercial physical and biological research). As per prior research (i.e., Krigman et al.,
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1999; Ritter, 1991) equity carve-outs, unit offers, American Depository Receipts (ADRs) of
companies already listed in their home countries, foreign firms (typically using F-1 filings)
that went public in the U.S., small firms that choose to file for its IPO using the SB-2 program
(instead of the traditional S-1 program), reverse leverage buyouts, and issues with an offer
price below $5.00 per share were excluded. We then augment these data with data from
Thomson Financial’s VentureXpert database with additional items and corrections using the
NASDAQ website and the Venture Capital Journal. The final sample consists of 197 venturebacked U.S. biotechnology IPOs during the 2003-2014 time period8.
The Thomson Reuters Datastream database is the source for IPO dates, stock prices and
returns after the IPO. All other IPO information including the proceeds, the number of shares,
the offer price, underwriting discounts and commissions, underwriter information, and
founding dates (which are cross-checked with the list on Professor Jay Ritter’s website9) were
hand-collected from SEC filings made available through the EDGAR (Electronic DataGathering, Analysis, and Retrieval) database. Form S-1 is the initial document on the EDGAR
system for registering IPOs with the SEC. After the initial S-1 filing, the company typically
will submit additional amended filings (S-1/A filings) to the EDGAR system. Form 424 is the
final IPO prospectus, filed at or within days after the IPO. 15.2% of our sample actually filed
the Form 424 on EDGAR after the date when the IPO started trading on a major stock
exchange according to the trading dates obtained from the Thomson Reuters Datastream
database. All Form 424 variants (e.g., 424A, 424B1, 424B8), Form S-1, and Form S-1/A
filings are downloaded from the SEC’s EDGAR Web site for the period 2000-2014.10 For
each firm, we consider the first S-1 filing, the first S-1/A filing with details on price range and
the number of shares, and any amendments made prior to the to the IPO date. The last filing
can be an S-1/A or a 424 variant.11
7
In the period of 2000-2002, a total of 50 venture-backed biotechnology companies went public.
The sample of venture-backed biotechnology firms represents 27.7 percent of the total number of venturebacked firms that went public over the period 2003-2013 according to NVCA Yearbook available at
www.nvca.org. The second and third largest industries are software (15.1 percent), and, medical devices and
equipment (9.4 percent), respectively.
9
http://bear.warrington.ufl.edu/ritter/ipodata.htm
10
Since our VC reputation measure is based on the IPO market share calculated over the preceding 3 calendar
years and our first year is 2003, the starting year is 2000. In the period 2000-2002, 50 venture-backed
biotechnology firms went public.
11
If an IPO is withdrawn, the firm typically files a registration withdrawal.
8
- 10 -
3.2 Insider participation
To assess the participation by existing stockholders, including venture capitalists, in the IPO
we examine the prospectus front page, ‘The Offering’ section in the prospectus summary, and
‘Transactions with related persons’ (participation in offering), ‘Principal Stockholders’,
‘Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters’ sections in each IPO prospectus.12 It is important to note that underwriters typically
will receive the same underwriting discount on any shares sold to the public in the offering
(even if they are purchased by insiders)13.
Our four variables are: (1) insider participation – the fraction of the total shares offered in the
IPO that pre-IPO shareholders buy, (2) venture capital participation - the fraction of the total
shares offered in the IPO that only the venture capitalist/s buys, and, (3) corporate
participation – the fraction of the total shares offered in the IPO that only the corporate
partners buys, (4) venture and corporate participation – the fraction of the total shares offered
in the IPO that the venture capitalist/s and the corporate partner buys. In the robustness
analysis section, we compare indications of interest in purchasing shares of common stock in
the IPO with actual purchasing of shares in the IPO to control for false signaling.
Table 1, Panel A, reports the distribution of IPOs during the period 2003 to 2014. As reported
in other papers (e.g. Gao et al., 2011) there have been significant variations in the number of
firms going public over the last ten years. During the financial crises in 2008-2009, only one
firm in our sample went public, whereas the number of IPOs significantly increased in the
years 2013-2014. The fraction of IPOs in which preexisting investors buy shares has steadily
increased over the time period. In particular, it is significantly higher in the post-2008
financial crisis period compared to the period prior to the 2008 financial crisis. Over the past
five years, the fraction of IPOs with insider participation has averaged 81.7 percent, which is
significantly higher than the average of 42.4 percent prior to the financial crisis in 2008.
Interestingly, despite the increased number of IPOs in the past two years, the fraction of
insider participation has averaged as high as 79.2 percent.
12
A typical example from Concert Pharmaceuticals IPO prospectus: ”Certain of our existing principal
stockholders and their affiliated entities, as well as Celgene, one of our collaborators, have indicated an interest
in purchasing an aggregate of up to $16.7 million of shares of common stock in this offering at the initial public
offering price. However, because indications of interest are not binding agreements or commitments to purchase,
the underwriters could determine to sell more, less or no shares to any of these potential purchasers and any of
these potential purchasers could determine to purchase more, less or no shares in this offering”.
13
If the underwriting discount only included shares sold to new outside investors, preexisting investors would
have an incentive to participate in the offering to minimize costs of the offering.
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Table 1. Venture-backed IPOs, 2003-2014
Panel A. Distribution of IPOs and insider buying/selling by preexisting investors in IPOs
Total number of
venture-backed
biotechnology IPOs
Year
Number of IPOs where
the preexisting investors
buy shares
Number of IPOs where
the preexisting investors
sell shares
Percent of IPOs where
the preexisting investors
buy shares
2003
7
2
0
28.6
2004
26
10
1
38.5
2005
13
7
1
53.8
2006
16
5
0
31.3
2007
15
9
1
60.0
2008
0
0
0
0
2009
1
0
0
0
2010
12
10
0
83.3
2011
9
7
0
77.8
2012
9
8
0
88.9
2013
37
28
0
75.7
2014
52
43
0
82.7
Total
197
129
3
65.5
Panel B. Distribution of insider participation levels in IPOs
40,0%
Percentage of IPOs
35,0%
30,0%
25,0%
20,0%
15,0%
10,0%
5,0%
0,0%
0
0 - 10 10 - 20 20 - 30 30 - 40 40 - 50 50 - 60 60 - 70 70 - 80 80 - 90 90 - 100
Fraction of IPO shares bought buy existing investors (%)
Notes: Panel A displays the annual number of venture-backed biotechnology IPOs, the number IPOs where the
preexisting investors (including venture capitalists and corporate partners) buy and sell shares, respectively, and
the fraction of IPOs where the preexisting investors buy shares. Panel B displays the distribution of insider
participation levels in IPOs on the basis of information in the IPO prospectus (Form 424B4).
Column 4 of Panel A, Table 1, displays the number of IPOs where the preexisting investors
sell shares. There are no purely secondary offerings and only three IPOs with a secondary
offerings component in addition to primary offerings. Purely primary offerings represent 98.5
percent of all IPOs over the entire period. For comparison, this contrasts the study by Lin and
Smith (1998), who documents that the lead investor sells shares in 27 percent of the total of
497 venture-backed IPOs over the period 1979-1990. Habib and Ljungqvist (2001) show that
approximately fifty percent of the 1376 U.S. IPOs (including also non venture-backed firms)
- 12 -
over the 1991-1995 period are pure primary offerings, less than one percent pure secondary
offerings and the remainder combine primary and secondary offerings. In fact, the frequency
of IPOs including secondary sales seems to have declined sharply over time. Ljungqvist and
Wilhelm (2003) provide evidence that the fraction of IPOs with secondary sales declined
from 37.1 percent in 1996 to 8.5 percent in 2000.
Table 1, Panel B, displays the frequency of insider buying over the sample period.
Approximately 34.0 percent involves no insider buying. 16.2 percent and 19.8 percent of
IPOs, respectively, have insider participation levels ranging from 10-20, and 20-30 percent,
respectively. 12.2 percent have insider participation of 40 percent and above. The 129 IPOs
were preexisting investors buy shares are distributed as follows: only venture capitalists
(107), only corporate partners (8), and, both venture capitalists and corporate partners (14).
Following Krishnan et al. (2011), our measure of venture capital reputation is a dummy taking
the value of 1 for issues backed by a VC (lead) with an IPO market share above the median of
all VCs, otherwise, the value is 0. The IPO market share is calculated as a venture capitalist’s
dollar market share of all venture-backed IPOs in the preceding 3 calendar years. For
robustness purposes, the venture capital reputation measure is also calculated on the basis of
cumulative IPO market share over the period of 2000 and onwards. We acknowledge that the
venture capital reputation measure may have some shortcomings14.
3.2 Dependent variable and control variables
The first set of tests examines IPO underpricing, or first-day returns, for the IPO sample. The
dependent variable, first-day return, is computed as the percentage change from the offer price
to the first-day closing price (Ritter, 1991). In terms of our independent variables, we include
several different control variables taken from the prior IPO literature that may influence firstday returns. Table 2 provides variable definitions of the specific IPO control variables.
14
It is also important to note that the venture capital reputation measure only considers past performance of
successful IPOs and do not include past performance of high profile private sales.
- 13 -
Table 2. Variable definitions
Variable
Definition/description
First-day returns
The percentage change from the offer price to the first-day closing price.
Insider participation
Fraction of the total shares offered in the IPO that pre-IPO shareholders buy.
VC participation
Fraction of the total shares offered in the IPO that the venture capitalist/s buys.
Corporate participation
Fraction of the total shares offered in the IPO that the corporate partner/s buys.
IPO market share
A venture capitalist’s dollar market share of all venture-backed IPOs in the
preceding 3 calendar years. For example, to analyze the long-run performance
of an IPO completed in 2003, the dollar value of all IPOs backed by a VC
during years 2000, 2001, 2002 is aggregated as a proportion of the total dollar
size of all venture-backed IPOs in the same 3-year period. The dollar size of
an IPO is defined as the gross proceeds excluding overallotment options. Each
VC investor is given full credit for a completed IPO that it backs.
Cumulative IPO market share
The dollar market share of IPOs that a VC backed between 2000 and the year
prior to the IPO.
VC reputation
An indicator variable for highly ranked lead VCs taking the value of 1 for
issues backed by a VC with an IPO market share above the median of all VCs,
otherwise, the value is 0. For robustness reasons, the measure of VC reputation
is also examined on the basis of cumulative IPO market share.
Insider ownership
Fraction of issuer’s shares held by all directors and executive officers as a
group. This measure excludes stakes held by anyone who is not represented on
the board and is not a senior executive of the firm (e.g. VC firms without a
board seat and corporate investors holding only small ownership stakes).
VC ownership
Fraction of issuer’s shares held by venture capitalists before the IPO.
Corporate ownership
Fraction of issuer’s shares held by corporate partners before the IPO.
Number of VCs
Number of venture capitalists with equity in the issuing firm before the IPO.
Underwriter reputation
Dummy taking the value of 1 if the lead underwriter of the IPO has an updated
Carter and Manaster (1990) rank of eight or more, else zero. The data is
obtained from Jay Ritter’s website
(http://bear.warrington.ufl.edu/ritter/ipodata.htm) with data on underwriter
reputation rankings between 1980 and 2011. For the years 2012-2014, the
underwriter reputation ranking for 2011 is used.
Syndicate size
The number of banks making up the syndicate.
Price revision
Percentage revision in the offer price from the mid-point of the filing range.
Share overhang
The number of shares retained divided by the number of shares in the IPO.
Expected issue size
The mean of the indicative price range times the mean of the number of shares
included in the issuer’s S-1 filing.
Issue size
The log value of the IPO gross proceeds measured as the offer price times the
number of shares sold (excluding the overallotment option).
Gross spread
Underwriting fee
Discounts and commissions (per share) paid to the underwriter as a percentage
of the offer price.
The fee that is paid to the underwriter as a payment for underwriting risk.
Days between S-1 and 424
The log value of the number of days between S-1 and 424.
Industry return
The value-weighted index return (NASDAQ biotechnology index) from the
S1-filing date to the IPO date.
The average first-day return of all IPOs that started trading during the
bookbuilding phase.
Contemporary underpricing
- 14 -
Post-IPO stock-return
volatility
The market model root-mean square error for each IPO over day +5 to day
+64 relative to their IPO date. The value is multiplied by 1,000.
Post-IPO abnormal stockreturn performance
The market-adjusted abnormal return for each IPO over day 0 to day 59
relative to their IPO date.
Firm age
The natural logarithm of unity plus the firm age (number of years since the
issuing firm was incorporated to the IPO date).
Money left on the table
The first day return times the total amount of shares offered in the IPO (net of
any insider participation).
Promotion costs
The promotion costs typically includes fees associated with SEC registration,
exchange, legal, printing, accounting, roadshow and other, but excludes the
underwriter fee.
Notes: This table provides variable definitions of experimental and control variables.
3.3 Data summary statistics
Table 3 shows data summary statistics for the dependent, experimental and control variables.
The average (median) first-day return is 11.16 (1.67) percent, which is similar to previous
studies (Panel A of Table 3). The large difference between mean and median first-day returns
are a product of a few observations with very high initial returns (see e.g. Loughran and
McDonald, 2013). The average precommitments by insiders to participate in the offering in
the first S-1 or S-1/A-filing are $8.2 million and increases to an average of $15.9 million in
the final prospectus. Preexisting investors purchase on average 17.6 percent of the shares
offered in the IPO, which translates into shares worth of $15.9 million on average. Venture
capitalist investors comprise the largest fractions of preexisting investors and purchase on
average 16.7 percent of the shares offered. The fraction of IPOs with corporate participation is
relatively small, which is reflected in the small average figure in the table. However, the IPOs
with corporate participation have an average (median) of 15.23 (13.05) percent (untabulated).
The average (median) issue size is $64 ($56) million. The measure of VC reputation, which is
based on IPO market share, has a mean value of 0.50. The median number of VC investors
owning 5 percent or more pre-IPO equals 5. Using the Loughran and Ritter (2004) updated
version of the Carter and Manaster (1990) underwriter reputation ranking (scaled from 0 to
9.1), the mean underwriter ranking is 8. The mean syndicate size of the investment banks is
4.2. Although not shown in Appendix 1, the average underwriting syndicate involved 14
banks in 2000, decreasing to 7 in 2003, and has averaged 4 since 2010. The average price
revision from the mean of the indicative price range to the final offer price equals 79.9 percent
(unchanged equals 100 percent). The price revision distribution is highly skewed, where 57
percent are priced below range, 36 percent are priced in range and only 7 percent above range.
- 15 -
Table 3. Descriptive statistics
Variable
Panel A. Offering characteristics
First-day returns (%)
Total shares before offering
Number of primary shares issued
Number of primary shares purchased
Insider participation (S1) ($ millions)
Insider participation (424) ($ millions)
ΔInsider participation ($ millions)
Insider participation (%)
VC participation (%)
Corporate participation (%)
VC reputation
Number of VCs
Underwriter reputation
Syndicate size
Price revision (%)
Share overhang
Expected issue size ($ millions)
Issue size ($ millions)
Gross spread (%)
Underwriting fee ($ millions)
Days between S-1 and 424
Industry return (%)
Contemporary underpricing (%)
Post-IPO stock return volatility
Post-IPO abnormal stock-return
performance (%)
Panel B. Company characteristics
Insider ownership (PRE) (%)
VC ownership (PRE) (%)
VC ownership (POST) (%)
Lead VC ownership (PRE) (%)
Lead VC ownership (POST) (%)
Corporate ownership (PRE) (%)
Firm age (years)
Mean
Std. dev.
Q1
Median
Q3
11.16
15,436,841
6,008,658
1,173,413
8.23
15.90
2.18
17.58
16.71
0.93
0.50
4.60
8.01
4.24
79.92
3.27
70.55
64.05
6.98
4.37
108.69
5.95
12.61
76.10
5.67
25.04
7,597,470
2,114,586
1,457,654
12.40
10.78
8.00
17.63
17.75
4.41
0.50
1.69
1.30
1.58
23.57
1.25
23.51
28.93
0.21
2.05
102.08
10.33
11.80
190.67
31.37
-1.05
10,946,482
5,000,000
0
0
9.18
0
0.00
0.00
0.00
0.00
3.00
8.00
4.00
61.54
2.52
60.00
45.00
7.00
2.94
44.00
-0.29
3.88
20.01
-16.65
1.67
14,118,970
5,750,000
823,530
0
14.80
0
14.64
13.60
0.00
0.00
5.00
8.50
4.00
78.57
3.09
72.00
56.00
7.00
3.85
84.00
6.21
9.96
34.31
0.18
17.36
18,055,753
6,500,000
1,588,235
15.00
19.88
5.53
27.73
26.85
0.00
1.00
6.00
9.00
4.00
100.00
3.72
75.60
77.13
7.00
5.54
118.00
10.69
18.88
65.08
24.89
55.21
67.46
48.68
24.62
17.83
3.84
8.19
22.28
21.40
15.85
13.35
9.77
7.63
4.17
39.60
56.60
39.60
16.80
11.30
0.00
5.25
57.10
71.50
50.90
21.50
15.71
0.00
7.21
71.40
83.20
60.70
28.70
20.40
6.33
10.48
Panel C. Wealth losses
Money left on the table ($ millions)
8.72
19.84
-0.55
0.69
7.63
Promotion costs ($ millions)
2.34
0.71
1.84
2.31
2.78
Promotion costs as % of issue size
4.12
1.81
2.86
3.82
5.10
Total wealth losses
11.04
19.97
1.40
3.48
10.26
Wealth losses per old share
0.67
1.17
0.09
0.26
0.72
Promotion costs per old share
0.18
0.13
0.12
0.17
0.23
Notes: This table provides descriptive statistics of the dependent and independent variables. The variables are
described in Table 2.
.
- 16 -
The mean (median) share overhang, defined as the number of shares retained divided by the
number of shares in the IPO, equals 3.3 (3.1). The gross spread is surprisingly constant
averaging 7.0 percent of total gross proceeds, which is similar to past empirical research (e.g.
Chen and Ritter, 2000). This translates into an average of $4.4 million in underwriting fees.
The average (median) number of days between the first S-1 filing and the IPO date is 109
(84), indicating that it takes some 3-4 months on average from first filing, through roadshows
and book-building until IPO date conditional on going public. Firms on average go public
following a period of positive stock market performance and the stock market continues to
perform well in the post-IPO period. The return of the NASDAQ biotechnology index over
the three months prior to the IPO date is on average 6.0 percent and over the subsequent three
months 2.6 percent (untabulated). Contemporary underpricing, which is measured as the
average first-day return of all IPOs that started trading during the bookbuilding phase,
averages 12.6 percent. The post-IPO stock-return volatility, calculated using the market model
root-mean square error for each IPO over day +5 to day +64 relative to the IPO date, is highly
variable with an average of 76.1 and a standard deviation of 190.7. Companies tend to
outperform the market in the sixty-day period following the IPO. The post-IPO abnormal
stock-return performance is on average 5.7 percent, whereas the median is close to zero.
Regarding the ownership measures, the aggregate stake held by all directors and executive
officers as a group, whom we refer to collectively as insiders, is on average 55.2 percent
(Panel B of Table 3). This measure excludes stakes held by anyone who is not represented on
the board and is not a senior executive of the firm (e.g. VC firms holding no board seats, or
corporate investors holding only small ownership stakes). The collective fraction of shares
held by all venture capitalists owning more than five percent prior to the IPO, pre-IPO VC
ownership, averages 67.5 percent and declines to 48.7 percent post-IPO as an effect of equity
dilution15. The lead VC owns pre-IPO (post-IPO) on average 24.6 (17.9) percent. The average
(median) firm age at the time of the IPO is 8.2 (7.2) years, whereas the standard deviation of 4
years indicate a large variation.
In total, firms that went public left more than $1.96 billion on the table (untabulated), defined
as the number of shares sold times the difference between the first-day closing market price
and the offer price. After adjusting for insider purchasing, the total amount of money left on
15
The post-IPO VC ownership is likely to be slightly downward biased as the participation of insiders is not
included for the majority of IPOs.
- 17 -
the table is equal to $1.72 billion. To put this amount into perspective, it is more than double
the $861 million in investment banker fees (underwriter fee as a compensation for underwriter
risk) paid by the issuing companies. The average amount of dollar left on the table equals $8.7
million due to the presence of some highly underpriced offerings, whereas the median is close
to zero (Panel C of Table 3). The average promotion cost is equal to $2.3 million, which
represents approximately 4.1 percent of the issue size. Total wealth losses for the average
(median) issuer is $3.5 ($11.0) million, which on a per-share basis is equal to $0.67 ($0.26).
The Pearson correlation matrix for the independent variables used in the multivariate
regressions is presented in Table 4. The correlation between price revisions and issue size is
0.624. We refrain from controlling for issue size, because a decrease in price revisions is
likely to decrease the issue size as long as it is not counterbalanced with increasing the
number of shares offered. Habib and Ljungqvist (1998) also show that underpricing is strictly
decreasing in the size of the offering even when holding risk constant. Of the other bivariate
correlations, none of them exceeds a value of 0.47.
- 18 -
Table 4. Pearson correlation matrix
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
1. First-day returns
2. Insider participation
-0.116
(0.104)
3. VC participation
-0.108
(0.130)
0.971***
(0.000)
4. Corporate participation
-0.0292
(0.684)
0.093
(0.195)
-0.149**
(0.0364)
5. VC reputation
-0.077
(0.284)
-0.053
(0.459)
-0.062
(0.386)
0.039
(0.586)
6. Underwriter reputation
0.097
(0.175)
-0.176**
(0.013)
-0.198***
(0.005)
0.094
(0.188)
0.173**
(0.015)
7. Syndicate size
0.020
(0.778)
-0.190***
(0.007)
-0.194***
(0.006)
0.021
(0.775)
0.062
(0.388)
0.102
(0.155)
8. Price revision
0.454***
(0.000)
-0.415***
(0.000)
-0.414***
(0.000)
0.009
(0.902)
0.010
(0.886)
0.170**
(0.017)
0.015
(0.834)
9. Share overhang
0.178**
(0.012)
-0.471***
(0.000)
-0.460***
(0.000)
-0.031
(0.666)
0.084
(0.242)
0.229***
(0.001)
0.182**
(0.010)
0.379***
(0.000)
10. Issue size
0.386***
(0.000)
-0.164**
(0.022)
-0.161**
(0.024)
-0.008
(0.909)
0.054
(0.450)
0.368***
(0.000)
0.126*
(0.077)
0.624***
(0.000)
0.136*
(0.057)
11. Days between S-1 and 424
-0.196***
(0.006)
0.007
(0.922)
0.008
(0.908)
-0.006
(0.937)
0.056
(0.436)
-0.010
(0.885)
0.012
(0.870)
-0.369***
(0.000)
0.068
(0.344)
-0.388***
(0.000)
12. Industry return
0.156**
(0.029)
0.099
(0.167)
0.110
(0.125)
-0.048
(0.507)
-0.063
(0.376)
-0.156**
(0.029)
-0.096
(0180)
0.025
(0.729)
-0.079
(0.270)
-0.015
(0.832)
0.282***
(0.000)
13. Contemporary underpricing
0.075
(0.294)
-0.055
(0.441)
-0.034
(0.631)
-0.084
(0.239)
-0.056
(0.434)
-0.257***
(0.000)
-0.095
(0.185)
0.201***
(0.005)
-0.127*
(0.076)
0.035
(0.623)
-0.357***
(0.000)
0.078
(0.274)
14. Post-IPO stock return volatility
-0.000
(0.999)
0.232***
(0.001)
0.231***
(0.001)
-0.000
(0.996)
0.039
(0.599)
0.039
(0.598)
-0.009
(0.904)
-0.129*
(0.079)
-0.105
(0.154)
-0.027
(0.709)
0.079
(0.283)
0.125*
(0.087)
0.080
(0.278)
15. Post-IPO abnormal stock-return
performance
-0.047
(0.524)
0.067
(0.357)
0.059
(0.418)
0.036
(0.627)
0.063
(0.390)
0.155**
(0.033)
-0.021
(0.772)
-0.055
(0.454)
-0.017
(0.821)
0.192***
(0.008)
-0.169**
(0.020)
-0.102
(0.162)
0.028
(0.704)
0.441***
(0.000)
16. Insider ownership
-0.052
(0.471)
0.152**
(0.034)
0.169**
(0.017)
-0.078
(0.278)
-0.061
(0.397)
0.023
(0.747)
0.171**
(0.016)
-0.135*
(0.059)
-0.006
(0.935)
-0.044
(0.539)
0.003
(0.970)
0.091
(0.204)
-0.102
(0.154)
0.125*
(0.087)
0.071
(0.331)
17. VC ownership
-0.102
(0.155)
0.240***
(0.001)
0.279***
(0.000)
-0.169**
(0.018)
0.037
(0.603)
-0.082
(0.255)
0.006
(0.933)
-0.109
(0.129)
-0.294***
(0.000)
-0.094
(0.190)
-0.123*
(0.086)
0.032
(0.653)
0.102
(0.152)
0.152**
(0.038)
0.139*
(0.057)
0.336***
(0.000)
18. Corporate ownership
-0.037
(0.606)
-0.081
(0.258)
-0.112
(0.113)
0.136*
(0.056)
-0.031
(0.668)
0.075
(0.294)
-0.107
(0.135)
0.067
(0.349)
0.151**
(0.034)
0.065
(0.364)
0.137*
(0.055)
0.047
(0.516)
0.004
(0.961)
0.013
(0.860
-0.014
(0.850)
-0.131*
(0.066)
-0.275***
(0.000)
19. Firm age
0.033
(0.649)
0.028
(0.700)
-0.005
(0.945)
0.134*
(0.060)
-0.097
(0.176)
-0.030
(0.679)
-0.088
(0.218)
-0.064
(0.370)
-0.199***
(0.005)
-0.048
(0.507)
-0.052
(0.470)
0.030
(0.675)
0.220***
(0.002)
0.045
(0.538)
0.033
(0.649)
-0.161**
(0.024)
-0.125*
(0.079)
Notes: This table shows pair-wise correlations for the experimental and control variables in the regression equations. The variables are described in Table 2. The numbers
listed horizontally across the top row correspond to the numbers and variables listed vertically on the table. *, **, and *** denote the pair-wise correlations are significantly
different from zero at the 10%, 5%, and 1% levels, respectively. p-values are in brackets.
- 19 -
0.007
(0.924)
4. Empirical results
4.1 Univariate tests of IPO underpricing, participation and venture capital reputation
In this section, we examine univariate tests of IPO underpricing, venture capital participation
and venture capital reputation. For the purposes of this analysis, we only include venture
capitalists. The VC participation variable is a dummy taking the value of 1 if the venture
capitalist/s buys shares in the IPO, otherwise the value is zero. In the subsequent analysis in
the remaining part of the paper, our insider or venture capital participation measure is a
continuous variable as defined in Table 2.
Table 5. Univariate tests of initial returns for issues grouped by VC reputation and VC
participation
Issues where
venture capital
investors buy (%)
Issues where venture
capital investors do
not buy (%)
t-statistic for
difference in means
Mann-Whitney Zstatistic for medians
7.77***
0.60
(3.45)
[122]
16.67***
10.33
(5.90)
[75]
2.45
3.20
Venture capital investors
with established
reputation (%)
4.88
0.00
(1.29)
[59]
15.81***
6.88
(3.99)
[39]
1.93
2.96
Venture capital investors
without established
reputation (%)
10.47***
1.43
(4.12)
[63]
17.60***
12.18
(4.31)
[36]
1.57
1.72
1.24
0.31
2.43
0.42
All issues
t-statistic for difference in
means
Mann-Whitney Z-statistic
for medians
Notes: This table provides tests of differences in mean and median initial returns for issues grouped by venture
capital investors buy shares during the IPO and whether the lead venture capital investor has an established. The
sample consists of 197 venture-backed biotechnology IPOs in the years 2003-2014. Initial return, or first-day
return, is computed as the percentage change from the offer price to the first-day closing price. Median values
are in italics, p-values are displayed in parentheses and the number of observations are display in brackets. *, **,
and *** indicate values that are significantly different from zero at the 10%, 5%, and 1% levels, respectively.
Following Krishnan et al. (2011), our measure of venture capital reputation is a dummy taking
the value of 1 for issues backed by a VC with an IPO market share above the median of all
VCs, otherwise, the value is 0. The IPO market share is calculated as a venture capitalist’s
dollar market share of all venture-backed IPOs in the preceding 3 calendar years. Results of
the tests of differences in mean and median initial returns for issues grouped by the reputation
of the lead venture capital investor and by whether the existing venture capital investor buys
shares during the IPO are reported in Table 5. As expected, mean and median initial returns
are lowest when venture capitalists buys shares in the IPO, and highest when they do not.
- 20 -
There is also some weak evidence that IPOs in which venture capitalists with an established
reputation buy shares experience a lower level of underpricing. These results are generally
consistent with Lin and Smith (1998). They find that initial returns are highest when lead
venture capital investors with established reputations sell, and lowest when they do not.
4.2 IPO underpricing and insider participation
In this section, we examine the association between IPO underpricing and insider
participation. We estimate an ordinary least squares (OLS) regression of first-day (or initial)
returns on our experimental and control variables to provide a benchmark estimation model.
Since underwriters determine the offer price, and thus the price revision and underpricing,
simultaneously during the bookbuilding process, Benveniste and Spindt (1989) argue that
price revisions and underwriter choice should be modeled simultaneously. To control for
potential endogeneity, we estimate a two-stage least squares (2SLS) regression model that
treats both price revisions and underwriter choice as endogenous. Standard errors are adjusted
for the potential bias caused by time clustering. They rely on the assumption that observations
are independent for companies that go public at different points in time, but not necessarily
for companies which go public in the same month. Thus, they are more conservative than
White (1980) standard errors. As noted earlier, we predict a negative association between
underpricing and our measures of insider participation (preexisting investors, venture
capitalists, reputable venture capitalists, and corporate partners). We control for valuerelevant information during the bookbuilding period using our spillover variables as well as
several firm and offer characteristics.
The results of the regression analyses are reported in
Table 6. The dependent variable, first-day return, is defined as the percentage change from the
offer price to the first-day closing price. Note that the coefficients that are reported are
estimated conditional upon completing the offering. Therefore, some caution should be taken
in interpreting the coefficients because extremely negative feedback during the bookbuilding
period increases the likelihood of an offer being withdrawn. The coefficient estimates are
stable across all models, reported in models (1) to (7), and the explanatory power of the
regressions is high (R2 ranging from 22.8 to 26.0 percent).
- 21 -
Table 6. OLS regressions of first-day returns (IPO underpricing)
(1)
Initial
return
OLS
(2)
Initial
return
OLS
(3)
Initial
return
OLS
(4)
Initial
return
OLS
(5)
Initial
return
OLS
(6)
Investmen
t bank
ranking
OLS
(7)
Initial
return
2SLS
0.120
(0.616)
0.128
(0.535)
-0.150
(0.411)
0.149
(0.436)
-0.276**
(0.017)
-0.256**
(0.019)
0.251
(0.318)
-0.286***
(0.007)
-0.607**
(0.019)
-0.409
(0.128)
-0.013
(0.919)
0.453***
(0.000)
Pre-IPO ownership
Insider ownership
-0.003
(0.970)
-0.085
(0.326)
VC ownership
-0.326**
(0.047)
Corporate ownership
Insider participation at the
IPO
0.071
(0.746)
Participation
VC participation
Corporate participation
Reputation
-0.036
(0.347)
VC reputation
Spillover variables
Mean contemporary
underpricing
Industry return
-0.137
(0.430)
0.387***
(0.003)
-0.115
(0.505)
0.396***
(0.003)
-0.118
(0.480)
0.388***
(0.003)
-0.116
(0,492)
0.383***
(0.003)
-0.108
(0.374)
0.430***
(0.001)
Instrument
0.804***
(0.001)
ln(expected issue size)
Firm and offer characteristics
0.008
(0.823)
0.011
(0.763)
0.010
(0.798)
0.013
(0.752)
0.020
(0.551)
0.431***
(0.001)
0.427***
(0.001)
0.451***
(0.010)
0.469***
(0.010)
0.458**
(0.013)
0.333***
(0.007)
0.452**
(0.032)
Firm age
0.0623
(0.482)
0.045
(0.586)
0.069
(0.433)
0.084
(0.361)
0.079
(0.248)
-0.002
(0.988)
0.103
(0.158)
Firm size
0.039
((0.401)
0.041
(0.394)
0.039
(0.402)
0.043
(0.343)
0.035
(0.345)
0.262***
(0.000)
-0.007
(0.933)
Gross spread
-1.937
(0.697)
-1.771
(0.714)
-1.630
(0.752)
-1.182
(0.821)
-2.194
(0.642)
-8.102
(0.478)
-0.273
(0.960)
Share overhang
0.164
(0.506)
0.148
(0.559)
0.187
(0.357)
0.207
(0.271)
0.197
(0.229)
-0.106
(0.735)
0.168
(0.300)
Days between S-1 and 424
-0.0002
(0.167)
-0.0001
(0.280)
-0.0002
(0.166)
-0.0002
(0.155)
-0.040*
(0.058)
0.0002
(0.422)
-0.0002*
(0.055)
Constant
-13.006
(0.171)
-14.070
(0.149)
-10.201
(0.470)
-7.789
(0.594)
-0.221
(0.594)
-0.672
(0.492)
-0.548
(0.180)
Underwriter ranking
Price revision
- 22 -
0.121
(0.477)
Number of observations
Adj R2
F-value
(p-value)
197
0.245
5.04
0.000
197
0.256
4.69
0.000
197
0.246
5.98
0.000
197
0.253
5.80
0.000
197
0.260
10.22
0.000
197
0.256
16.80
0.000
197
0.228
103.92
0.000
Notes: This table provides the estimates of the ordinary least squares (OLS) regressions. The sample consists of
197 venture-backed biotechnology IPOs in the years 2003-2014. The dependent variable, first-day returns, is
computed as the percentage change from the offer price to the first-day closing price. The independent variables
are defined in Table 2. Standard errors are adjusted for time clustering by assuming that observations are
independent for companies at different points in time, but not necessarily for companies which go public in the
same month. They are more conservative than White (1980) standard errors. p-values are displayed in
parentheses. *, **, and *** indicate values that are significantly different from zero at the 10%, 5%, and 1%
levels, respectively.
In models (1) and (2), we introduce our pre-IPO ownership measures. Leland and Pyle (1977)
argue that insider ownership can be a signal of firm quality. Ljungqvist and Wilhelm (2003)
find evidence that underpricing is larger when pre-IPO insider ownership stakes are smaller
and more fragmented16. However, pre-IPO insider ownership stakes appear to have little
influence on underpricing. In model (1), the coefficient on insider ownership is negative, but
not statistically significant (p-value = 0.970). The insider ownership measure excludes stakes
held by anyone who is not represented on the board and is not a senior executive of the firm.
In model (2), we instead include pre-IPO ownership of venture capitalists and corporations.
Similar to Ljungqvist and Wilhelm (2003), pre-IPO ownership stakes by venture capitalists is
unassociated with underpricing. In contrast, pre-IPO ownership stakes by corporate partners is
negatively associated with IPO underpricing (p-value < 0.05).
Model (3) introduces insider participation, measured as the fraction of the total shares offered
that preexisting shareholders buy. The coefficient on insider participation is insignificant (pvalue = 0.746) maybe because enough preexisting shareholders are viewed as compromised in
such a way that a subscription precommitment provides no certification. This result does not
necessarily mean that there is no certification effect by participation by preexisting
shareholders in the offering. Subscription precommitments set a lower bound on expected
take-up (as long as there is no false signaling) and may decrease the likelihood of
withdrawing the offering.17
In model (4), we disentangle insider participation into participation by venture capitalists and
corporations, respectively. The coefficient on VC participation is positive, although
16
Ljungqvist and Wilhelm (2003) document that the large levels of IPO underpricing during 1999 and 2000 can
be accounted for by the decline in pre-IPO insider ownership.
17
We acknowledge that there may be alternative explanations. For example, Allen and Faulhaber (1989),
Grinblatt and Hwang (1989), and Welch (1989) develop models on sequential stock sales based on signaling
theory. They argue that issuers deliberately underprice new issues in order to ‘leave a good taste’ with investors,
who subsequently will be more willing to purchase additional shares in follow-on offerings.
- 23 -
statistically insignificant (p-value = 0.616). In contrast, the coefficient on corporate
participation is negatively associated with underpricing and statistically significant (p-value <
0.05). This is consistent with Nicholson et al. (2005), who argue that if investors have less
information than pharmaceutical firms regarding the likely success of a biotech firm’s
products and the quality of its science and management, then by doing a deal with a
pharmaceutical firm, a biotech firm can signal its quality to financial markets. This contrasts
the study by Ozmel et al. (2013), who find no association between IPO underpricing and
alliance activity for a sample of venture-backed biotechnology firms. Unlike our measure of
corporate participation in the IPO, as a measure of equity ownership, their alliance activity
measure measures the total number of alliances over the last five years, which may indicate
that at least part of the quality signal that the alliances provide may already be incorporated
into the offer price.
In model (5), we include the venture capital reputation variable, which is a dummy variable
taking the value of 1 for issues backed by a VC with an IPO market share above the median
of all VCs over the preceding three years, otherwise the value is 0. The coefficient on VC
reputation is statistically insignificant (p-value = 0.347). In untabulated tests, VC participation
is interacted with VC reputation. However, the coefficient of the interaction term is
statistically insignificant (p-value > 0.05).
The coefficients estimated for our spillover variables yield consistent results across all
models. The coefficient for contemporary underpricing is negative, but not statistically
significant (p-value > 0.05). In contrast, the coefficient for industry return, defined as the
industry return from the S-1 filing date to the IPO date, is positive and significant (p-value <
0.01) across all models. Among firm characteristics, the coefficient on price revisions is
statistically significant (p-value < 0.05) across all models. This is consistent with several other
papers (Hanley, 1993; Lowry and Schwert, 2002), who document that a very substantial
component of IPO first-day returns is the degree to which underwriters adjust the offer price
relative to the mid-point of the initial IPO filing price range18.
In models (1) – (5), we ignored that not all of the variables in the underpricing model are
exogenously determined. Benveniste and Spindt (1989) argue that price revisions and
underpricing should be modeled simultaneously. In particular, conditional on information
18
Hanley (1993) document that the first-day return is related to the revision in the offer price; IPOs where the
offer price is revised upward see much higher first-day price jumps, on average, than those where the offer price
is revised downward.
- 24 -
revealed during bookbuilding, the underwriter simultaneously determines the offer price (and
thereby the price revision) and how much money to leave on the table (underpricing).
Therefore, we estimate a two-stage model that treats both underwriter choice and price
revisions in the underpricing regression as endogenous. In the first stage, we regress
underwriter ranking on all independent regressors in model (4) and one additional variable to
ensure identification: the log of the intended offer size, in millions of dollars. The economic
rationale for the instrument is as follows. A given degree of percentage underpricing
translates into a larger wealth loss to the preexisting shareholders, the larger the offering. This
in turn creates an incentive to choose a top-tier underwriter in an attempt to reduce the degree
of underpricing19. The underwriter ranking equation is reported as model (6). In short, highranked underwriters are selected by larger firms and those filing larger offers. Using the
predicted value for underwriter ranking from model (6) as instruments, model (7) provides
consistent estimates of the effect of underwriter ranking on underpricing. A comparison of the
OLS coefficients in model (4) and the 2SLS coefficients in model (7) reveals little change in
the influence of our measures of insider participation and the firm and offer characteristics,
indicating that our results for these variables appear robust.
4.3 Insider participation and offer price revisions
In this section, we examine the association between price revisions from the mid-point of the
filing range and insider participation. The bookbuilding theory of IPO pricing (e.g.
Benveniste and Spindt, 1989; Benveniste and Wilhelm, 1990; Sherman and Titman, 2002)
focuses on information production in the time interval between the S-1 and 424 filing.
Revision in the offer price is assumed to reflect information acquired from informed
investors. Since underpricing reflects partial adjustment to the revelation of positive
information, and underpricing and price revisions are implicitly simultaneously determined
(Benveniste and Spindt, 1989), we first use ordinary least squares (OLS) to estimate our price
revision regression and then two-stage least squares (2SLS) regression to allow for potential
endogeneity of key explanatory variables (Ljungqvist and Wilhelm, 2003). Benveniste and
Spindt (1989) and Sherman and Titman (2002) consider underpricing as compensation to
19
In a case of one endogenous regressor and one instrument, a low correlation between instrument and the
endogenous variable would indicate a weak instrument. The correlation coefficient is 0.392. For intended offer
size to be a valid instrument, we examine the potential weakness of the instrument by testing the joint
significance of the coefficient of the instruments is less than 10. The partial R 2 is 0.0514 and the partial F-
- 25 -
investors for the revelation of positive information about the IPO valuation during the
bookbuilding process, which implies a positive association between offer price revisions and
underpricing (Hanley, 1993).
Ljungqvist and Wilhelm (2003) argue that insiders should bargain for more aggressive
positive revisions when their ownership stakes are larger and more concentrated. Hence, we
anticipate a positive association between price revision and our various measures of pre-IPO
ownership. We also control for valuation-relevant information that may spill over during a
company’s bookbuilding phase. Loughran and Ritter (2002) find evidence that the
compounded market returns for the 15-day period prior to the IPO are significantly positively
associated with underpricing and suggest that underwriters do not incorporate all public
information into the offer price that becomes available during the registration period. Lowry
and Schwert (2004) show that the significance of market returns originate from private
information during the filing period, which is not incorporated into the offer price. Following
Ljungqvist and Wilhelm (2003), we use an industry-specific index to capture spillover of
information from firms that share a common valuation factor with the issuing firm. The
industry index is defined as the value-weighted index return (NASDAQ biotechnology index)
from the S-1 filing date to the IPO date. Benveniste et al. (2002) argue that offer price
revisions incorporate spillover of information from contemporaneous issuers completing an
IPO between the issuing firm’s S-1 filing and the offering date. Contemporary underpricing is
computed as the average first-day return of all IPOs that started trading during the
bookbuilding phase. Finally, we also control for firm and offer characteristics, such as
underwriter ranking, syndicate size, firm age, firm size, share overhang, and the number of
days between S-1 and 424.
Standard errors are adjusted for time clustering by assuming that observations are independent
for companies that go public at different points in time, but not necessarily for companies
which go public in the same month. Thus, they are more conservative than White (1980)
standard errors. Dolvin and Pyles (2006) find a negative association between venture
capitalist quality and price revision and argue that this is consistent with view that reduced
asymmetry should result in less uncertainty of the offer price, which should produce smaller
offer price revisions. Consistent with this view, our expectation is that if insider participation
statistic from the first stage regression is 10.987. Hence, we can consider the intended offer size to be a valid
instrument.
- 26 -
Table 7. Least-squares offer price revision regressions
(8)
Price
revision
OLS
(9)
Price
revision
OLS
(10)
Price
revision
OLS
(11)
Price
revision
OLS
(12)
Price
revision
OLS
(13)
Price
revision
2SLS
Pre-IPO ownership
Insider ownership
-0.142**
(0.034)
VC ownership
-0.061
(0.501)
Corporate ownership
0.030
(0.889)
Insider participation at the
IPO
-0.358***
(0.000)
Insider participation
VC participation
Corporate participation
-0.387***
(0.000)
-0.380***
(0.000)
-0.006
(0.979)
-0.011
(0.959)
ΔInsider participation (S-1 to
424)
-0.009***
(0.002)
Spillover variables
Mean contemporary
underpricing
0.424***
(0.003)
0.316*
(0.088)
0.453***
(0.001)
0.280
(0.137)
0.369***
(0.005)
0.292
(0.103)
0.372***
(0.005)
0.305*
(0.096)
0.235**
(0.032)
0.182
(0.231)
0.406**
(0.015)
0.326*
(0.078)
0.103***
(0.007)
0.103***
(0.001)
0.094***
(0.008)
0.092***
(0.010)
0.073**
(0.014)
0.147
(0.301)
Syndicate size
-0.003
(0.743)
-0.006
(0.524)
-0.011
(0.232)
-0.010
(0.234)
-0.011
(0.242)
-0.010
(0.210)
Firm age
-0.049
(0.605)
-0.038
(0.684)
-0.033
(0.714)
-0.043
(0.640)
-0.054
(0.506)
-0.040
(0.653)
Firm size
-0.024
(0.580)
-0.027
(0.538)
-0.043
(0.300)
-0.051
(0.206)
-0.024
(0.519)
-0.071
(0.318)
Share overhang
1.048***
(0.000)
1.022***
(0.000)
0.789***
(0.001)
0.752***
(0.001)
0.673***
(0.002)
0.731***
(0.001)
Days between S-1 and 424
-0.0005**
(0.011)
-0.001**
(0.015)
-0.0005***
(0.010)
-0.0005**
(0.011)
-0.0002
(0.122)
-0.0005***
(0.008)
0.147
(0.434)
0.131
(0.564)
0.386*
(0.059)
0.423**
(0.033)
0.436***
(0.010)
0.419**
(0.022)
197
0.301
8.13
0.000
197
0.287
7.25
0.000
197
0.338
10.53
0.000
197
0.345
10.65
0.000
197
0.490
24.00
0.000
197
0.337
100.28
0.000
Industry return
Firm and offer characteristics
Underwriter ranking
Constant
Number of observations
Adj R2/ R2
F-value /Wald chi2
(p-value)
Notes: This table provides the estimates of the ordinary least squares (OLS) regressions. The sample consists of
197 venture-backed biotechnology IPOs in the years 2003-2014. The dependent variable, price revision, is
computed as the percentage change from the offer price to the mid-point of the filing range. The independent
variables are defined in Table 2. Standard errors are adjusted for time clustering by assuming that observations
are independent for companies at different points in time, but not necessarily for companies which go public in
- 27 -
the same month. They are more conservative than White (1980) standard errors. p-values are displayed in
parentheses. *, **, and *** indicate values that are significantly different from zero at the 10%, 5%, and 1%
levels, respectively.
helps certify the offer price, there will be a negative association between price revisions and
insider participation.
The results of the regression analyses are reported in Table 7. Once again, the coefficient
estimates are stable across all models, reported in models (8) to (13), and the explanatory
power of the regressions is high (R2 ranging from 28.7 to 49.0 percent). Pre-IPO ownership
stakes show some mixed results. In model (8), the coefficient on insider ownership is negative
and statistically significant (p-value < 0.05), which contrasts the view that insiders should
bargain for more aggressive positive price revisions when their pre-IPO ownership stakes are
larger and more concentrated. In contrast, in model (9), we instead include pre-IPO ownership
stakes of venture capitalists and corporations. Similar to Ljungqvist and Wilhelm (2003), we
find no association between pre-IPO ownership stakes by venture capitalists and corporations
with price revisions.
In model (10), the coefficient on insider participation is negative and statistically significant
(p-value < 0.01). In model (11), we disaggregate the insider participation ratio into purchases
by venture capitalists and corporations. Consistent with expectations, the coefficient on VC
participation is negative and statistically significant (p-value < 0.01), whereas the coefficient
on corporate participation is negative, although not statistically significant (p-value > 0.05).
Typically, the first amended S-1 filing contains information about the number of shares, the
indicative price range and information about subscription commitments by existing investors.
If there is no demand for the shares at a given offer price, the venture capital investors may
either decide to withdraw the IPO or purchase a larger fraction than of the shares. The demand
side explanation is tested by examining changes in the amount of capital between the S-1/A
filing and the final prospectus that preexisting investors are willing to commit. In model (12),
we link offer price revisions with insider participation changes between the S-1 and 424
filings. For example, the ∆insider participation variable is defined as the difference in the
amount of dollar (in millions) that insiders have made indications of interest to buy in the 424
minus the amount in the S-1/A20. The coefficient is negative and statistically significant (pvalue < 0.01), which indicates that when the offer price is downward revised during the
- 28 -
bookbuilding period, preexisting investors commit to purchase additional shares. This
provides some support for the demand side explanation. If the issuing firm receives negative
feedback during the bookbuilding period, preexisting investors may commit to purchase
additional shares or the firm may decide to withdraw the offer.
Most of our coefficients estimated for our spillover and control variables yield consistent
results across all models. The coefficient for contemporary underpricing is positive and
significant (p-value < 0.05), which is consistent with other papers (e.g. Ljungqvist and
Wilhelm, 2003). The coefficient for industry return is positive, but only significant at the 10
percent level in some of the models. Among firm and offer characteristics, the coefficient on
underwriter ranking is positive and statistically significant (p-value < 0.05) across all models.
This is consistent with the view that higher ranked banks extract more information from
potential investors and integrate it more aggressively in the offer price. Finally, the coefficient
on share overhang is positive and statistically significant across all models (p-value < 0.01).
This suggests that when preexisting investors retain a larger fraction of the shares relative to
the number of shares offered in the IPO, the offer price is more aggressively revised.
In the next step we estimate a two-stage least squares (2SLS) regression to allow for potential
endogeneity of key explanatory variables (Ljungqvist and Wilhelm, 2003). We use the
predicted values for underwriter ranks from model (6) in Table 7 in the model (11)
specification of the price revision regression. Model (13) in Table 7 reports the results. A
comparison of the OLS coefficients in model (11) and the 2SLS coefficients in model (13)
reveals little change in the influence of our measures of insider participation and most of the
firm and offer characteristics, indicating that our results for these variables appear robust.
Note, however, that the coefficient of underwriter ranking no longer is statistically significant.
4.4 Buying of shares during the IPO by venture capital investors
Panel B of Table 1 shows that approximately 34.0 percent of all IPOs involve no venture
capital buying. Therefore, we use a Tobit estimator to accommodate the left-truncated nature
of the dependent variable. The dependent variable, venture participation, is computed as the
fraction of the total shares offered in the IPO that the venture capitalist/s buys.
20
We use the actual amount rather than the fraction of the total issue because offer sizes may change if price
revisions are not counterbalanced by the number of shares offered. However, untabulated tests show that instead
- 29 -
Table 8.Tobit model of the decision of the venture capital investors to buy shares in the
IPO of a portfolio company
(14)
Venture capital
participation
Tobit
0.201
[0.136]**
(0.021)
VC ownership
0.031
[0.021]
(0.914)
Corporate ownership
-2.028
[-1.366]***
(0.008)
Corporate participation
VC reputation
-0.010
[-0.007]
(0.758)
Mean contemporary underpricing
-0.100
[-0.067]
(0.528)
Industry return
0.283
[0.191]
(0.101)
Underwriter ranking
-0.046
[-0.031]
(0.263)
-0.395
[-0.266]***
(0.000)
Price revision
Issue size
0.134
[0.090]
(0.282)
Firm age
-0.062
[-0.042]
(0.462)
-0.891
[-0.600]***
(0.000)
Share overhang
-0.056*
[-0.038]*
(0.077)
Days between S-1 and 424
Constant
1.021
Number of observations
Log likelihood
LR chi2
(p-value)
197
-30.10
88.86
0.000
Notes: This table provides the estimates from the Tobit regression. The sample consists of 197 venture-backed
biotechnology IPOs in the years 2003-2014. The dependent variable, venture participation, is computed as the
fraction of the total shares offered in the IPO that the venture capitalist/s buys. The independent variables are
defined in Table 2. The first entry in the table is the coefficient estimates from the OLS regression. The second
using fraction of the total shares yield similar results.
- 30 -
entry (within angle brackets) is the marginal effects for the censored sample. The third entry (in parenthesis) is zstatistics for the marginal effect. Standard errors are adjusted for time clustering by assuming that observations
are independent for companies at different points in time, but not necessarily for companies which go public in
the same month. They are more conservative than White (1980) standard errors. *, **, and *** indicate values
that are significantly different from zero at the 10%, 5%, and 1% levels, respectively.
The results of the Tobit regression analysis is reported in Table 8. Venture capital investors
are more likely to purchase shares when they hold higher pre-IPO ownership stakes, when
offer prices are revised downwards, and when the dilution effect is larger. There is a negative
association with corporate participation, indicating that when there are no support from
corporations, venture investors are purchasing a larger fraction of the shares. Again, it is
important to note that the sample of firms represent only those firms that have completed an
IPO, and not those who have withdrawn from the offering.
4.5 Insider participation and post-IPO stock return volatility
This section examines the post-IPO stock return volatility of completed IPOs and the
association with insider participation and offer price revision. Several key theories of IPO
pricing (e.g. Ritter, 1984; Rock, 1986) suggest that uncertainty should matter in initial returns.
However, as Loughran and McDonald (2013) point out, the literature offers few direct and ex
ante proxies for uncertainty. Several of the frequently used ex ante proxies of uncertainty (e.g.
firm age, IPO gross proceeds, and sales) may also measure many other aspects of the offering.
Our expectation is that insider participation may help stabilize the pricing resulting in a lower
stock return volatility. The results of the OLS regression analyses are reported in Table 9. The
dependent variable, post-IPO stock return volatility, is the market model root-mean square
error for each IPO during days +5 to +64 (a 60-day period) relative to the IPO date. Following
Loughran and McDonald (2013), we exclude the first four days following the IPO to avoid
abnormal trading volume activity following the offering.
In model (22) the coefficient on insider participation is negative, although not statistically
significant (p-value > 0.05). In model (23), we disaggregate insider participation into VC
participation and corporate participation. The coefficient on VC participation is negative, but
not statistically significant (p-value > 0.05), which indicates that insider purchasing by
venture capitalists are unassociated with post-IPO stock return volatility. In contrast, the
coefficient on corporate participation is positive and statistically significant (p-value < 0.01).
- 31 -
Table 9. OLS regressions of post-IPO stock return volatility
(20)
Stock return
volatility
OLS
(21)
Stock return
volatility
OLS
(22)
Stock return
volatility
OLS
(23)
Stock return
volatility
OLS
Pre-IPO ownership
VC ownership
0.502
(0.106)
Corporate ownership
0.763
(0.377)
-0.359
(0.209)
Insider ownership
Insider participation at the
IPO
-0.173
(0.698)
Insider participation
-0.247
(0.590)
VC participation
2.770***
(0.000)
Corporate participation
Spillover variables
Mean contemporary
underpricing
0.963*
(0.066)
0.082
(0.900)
1.049**
(0.038)
0.258
(0.694)
1.057**
(0.035)
0.159
(0.807)
1.123**
(0.025)
0.201
(0.758)
Underwriter ranking
-0.081
(0.669)
-0.043
(0.813)
-0.059
(0.752)
-0.078
(0.675)
Syndicate size
0.064
(0.131)
0.070
(0.113)
0.060
(0.148)
0.045
(0.177)
0.605***
(0.000)
0.572***
(0.000)
0.585***
(0.000)
0.592***
(0.000)
Firm age
-0.,93
(0.219)
-0.567*
(0.070)
-0.510
(0.114)
-0.575*
(0.072)
Share overhang
0.684
(0.360)
0.364
(0.619)
0.256
(0.760)
0.245
(0.777)
Days between S-1 and 424
-0.324
(0.193)
-0.355
(0.150)
-0.334
(0.180)
-0.331
(0.191)
Constant
0.031
(0.971)
0.974
(0.200)
0.847
(0.330)
0.919
(0.299)
189
0.191
8.09
0.000
189
0.186
7.22
0.000
189
0.180
6.85
0.000
189
0.196
7.33
0.000
Industry return
Firm and offer characteristics
Up revision
Number of observations
Adj R2/ R2
F-value /Wald chi2
(p-value)
Notes: This table provides the estimates of the ordinary least squares (OLS) regressions. The sample consists of
197 venture-backed biotechnology IPOs in the years 2003-2014. The dependent variable, post-IPO stock return
volatility, is computed as the market model root-mean square error for each IPO over day +5 to day +64 relative
to their IPO date. The independent variables are defined in Table 2. Standard errors are adjusted for time
clustering by assuming that observations are independent for companies at different points in time, but not
necessarily for companies which go public in the same month. They are more conservative than White (1980)
- 32 -
standard errors. p-values are displayed in parentheses. *, **, and *** indicate values that are significantly
different from zero at the 10%, 5%, and 1% levels, respectively.
In untabulated tests, we study how our independent variables affect post-IPO abnormal stockreturn performance. Our expectation would be that leaving something on the table for public
investors may yield positive abnormal stock-return performance in the aftermarket. However,
the model has low explanatory power and the coefficients on the independent variables are
generally insignificant.
4.6 Ownership and managerial/monitoring involvement of venture capital investors in the
pre-/post-IPO period
Megginson and Weiss (1991) argue that venture capital investors certify the IPO issue price
by maintaining ownership in the company. Barry et al. (1990) suggest that ownership
retention provides both a signal of value and an ongoing commitment to monitor. The
certification hypothesis predicts that venture capitalists will retain substantial holdings in the
firm as a bonding mechanism for credible certification. The credibility of venture capitalists
in certifying an IPO is conveyed both through their investment in reputational capital and by
their holdings of the firm. To examine long-term involvement of venture capital investors
with portfolio companies, we examine the ownership of venture capital investors at the time
of the initial public offering and in the post-IPO offering period. Our expectation is that IPOs
in which preexisting investors, and specifically venture capitalist investors, commits capital
by purchasing a fraction of the IPO shares also result in longer holding periods.
Table 10 displays ownership data for all VC investors as well as the lead VC investor at the
IPO as well as in the years after the IPO. Lock-up typically occurs 180 days after the IPO.
Our post-issue ownership measures examine the holdings by venture capital investors that is
available in the DEF 14A annual filing that is filed a minimum of one (two or three) year/s
after the lock-up. Panel A of Table 10 displays the ownership levels for all venture capital
investors. The number of observations decrease over time due to that data are not yet
available. Venture investors hold large stakes on aggregate both prior to the IPO as well as
immediately following the IPO. Note also that the post-issue ownership at year 0 is likely to
be understated as the actual participation of insiders typically is not included in this measure.
Three years after the lock-up period expires still 46 of all IPOs include venture capital
investors holding an average of 21.5 percent of the total ownership stakes. In Panel B of Table
- 33 -
10 the lead venture capitalist hold large stakes at the IPO with a mean (median) level of
ownership of 24.6 (21.5) percent. Three years after the lock-up period, the same lead investors
at the IPO still owns on average 11.1 percent. In Panel C of Table 10, we test differences in
means and medians in ownership levels in IPOs with versus without venture capital
participation. The results indicate that when preexisting venture capital investors precommit
to participate in the IPO, they will also hold higher ownership stakes in the post-IPO period,
although the differences are not statistically significant in year 2 and year 3 after the lock-up.
Table 10. Long-term involvement of venture capital investors
Post-issue ownership (%)
Pre-issue
ownership (%)
Mean
Median
Year 1 after
lock-up
Year 0
Mean
Median
Mean
Median
Year 2 after lockup
Mean
Median
Year 3 after
lock-up
Mean
Median
Panel A. All VC investors
Number of
197
observations
VC ownership
67.46
71.50
Number of VCs
on the board
Percentage of
VCs on the board
Panel B. Lead VC investor
197
95
65
46
48.68
50.90
29.19
31.82
25.89
24.80
21.45
16.89
Lead VC
24.62
21.50
17.97
ownership
Percent of lead
investors with
directorships
Panel C. VC participation vs. no VC participation
15.90
12.23
11.77
11.98
10.30
11.05
8.85
VC participation
No VC
participation
t-statistic for
difference in
means
Mann-Whitney Zstatistic for
medians
53.20
47.55
35.83
26.95
38.00
23.90
28.00
23.84
26.05
23.00
23.19
20.12
16.15
18.14
72.62
61.33
74.30
65.60
3.75
52.30
44.38
3.56
3.65
2.40
3.38
1.07
2.39
0.62
1.26
Notes: This table provides details of pre- and post-offering characteristics of VC holdings. Data on institutional
holdings are hand-collected from IPO prospectuses (for the year of the offering) and from DEF 14A annual
proxy statements for each of the years thereafter. The proxy statement that follows a minimum of one year after
the lock-up period is classified as year 1. IPO prospectuses and annual proxy statements list shareholdings of
directors and beneficial owners of 5% or more. Thus a VC investor who owns less than 5% of shares and has no
board seat has no board seat need not be reported. An institutional holder is classified as a venture capitalist if (1)
the prospectus notes define him as such or (2) the shareholder has the word “venture” and/or “capital” in its title.
The information is cross-checked using information on venture capitalists from Pratt’s Guide to Venture Capital
Sources. Following Lin and Smith (1998) and Hochberg et al. (2007) a venture capitalist is designated as “lead”
if it holds the largest equity position of any venture capitalist. If two or more hold equivalent positions, the one
with representation on the board of directors is designated as lead.
- 34 -
0.38
5. Robustness tests
5.1 Wealth losses and insider participation
A potential explanation why the VC participation variable in the underpricing regression is
not statistically significant may be that at least part of the quality signals that venture
capitalists provide are already incorporated into the offer price. Alternatively, as suggested by
Barry (1989), underpricing improperly measures the indirect cost of going public, in
particular when share retention by preexisting owners is high, which also typically is the case
for venture-backed IPOs. Habib and Ljungqvist (2001) and Bradley and Jordan (2002) argue
that the degree to which preexisting owners care about underpricing depends on how much
they stand to lose from it. For example, owners who sell very few shares suffer only
marginally from underpricing, whereas owners who sell many shares have a greater incentive
to decrease underpricing. Hence, they argue that empirical tests of IPO underpricing theories
should be conditioned issuers’ incentives to take costly actions that reduce underpricing, and
compute wealth losses rather than underpricing returns. Dolvin and Pyles (2006) suggest that
any certification effect that reduces asymmetric information, and thereby the amount of
money left on the table, may likely be best measured by the actual wealth loss (i.e.
opportunity cost) to preexisting owners, and not necessarily underpricing. This is also
consistent to the goal of the firm to maximize the wealth of the existing shareholders, not
necessarily minimized underpricing.
Following the same argument, we could argue that the extent to which owners care about
underpricing depends on how much they buy at the IPO and pre-IPO ownership levels.
Owners with large pre-IPO ownership who do not purchase shares have a greater incentive to
decrease underpricing. Conversely, owners who buy many shares suffer only marginally from
underpricing as the dilution of pre-existing shares are counterbalanced by the wealth increase
of buying underpriced shares. Hence, the value of any underpricing is captured mainly by
existing shareholders (minimizing wealth transfers from current to new investors).
If preexisting shareholders do not sell any shares in the IPO, the wealth transfer per share
retained is only the dilution effect (𝑃∗ − 𝑃1 ):
𝑃 ∗ − 𝑃1 =
𝑁𝑛
(𝑃 − 𝑃0 ),
𝑁0 1
- 35 -
where 𝑃∗ is the unobservable value of the shares prior to the offering, 𝑃1 is the first-day
closing price, 𝑃0 is the IPO price, 𝑁𝑛 is the number of new shares issued, and, 𝑁0 is the
number of shares outstanding before the offering.21
Building on the model by Barry (1989), Habib and Ljungqvist (2001), and Dolvin and Pyles
(2006), we derive an explicit formula for calculating the opportunity cost of issuance (or
wealth loss). This measure adjusts for share overhang, underpricing and the fraction of shares
purchased by preexisting investors:
𝑊𝑒𝑎𝑙𝑡ℎ 𝑙𝑜𝑠𝑠 =
(𝑁𝑛 − 𝑁𝑉𝐶 ) × (𝑃1 − 𝑃0 )
,
𝑃1 𝑁𝐴 − 𝑃0 𝑁𝑛
where 𝑁𝑉𝐶 is the number of shares purchased by preexisting investors, 𝑁𝐴 is the total number
of shares outstanding after the issue, and the other variables are defined as before.
Panel A and Panel C of Table 3 show summary statistics for the input variables in the wealth
loss equation. The results of the regression analyses are reported in Table 11. Focusing on the
main variables of interests, we find that, in contrast to underpricing, the participation variables
in models (17) – (19) are all negative, consistent with reduced information asymmetry,
although not statistically significant.
21
For a derivation of the model, see Barry (1989).
- 36 -
Table 11. Wealth losses regressions
(15)
Wealth losses
OLS
(16)
Wealth losses
OLS
(17)
Wealth losses
OLS
(18)
Wealth losses
OLS
(19)
Wealth losses
2SLS
VC participation
-0.026
(0.189)
-0.024
(0.208)
Corporate participation
-0.055
(0.412)
-0.060
(0.367)
Pre-IPO ownership
VC ownership
-0.016
(0.362)
Corporate ownership
-0.061*
(0.086)
-0.002
(0.916)
Insider ownership
Insider participation at the
IPO
-0.027
(0.164)
Participation
Spillover variables
Mean contemporary
underpricing
-0.021
(0.366)
0.103***
(0.001)
-0.027
(0.277)
0.101***
(0.002)
-0.031
(0.201)
0.107***
(0.001)
-0.032
(0.180)
0.107***
(0.001)
-0.017
(0.599)
0.113***
(0.000)
-0.178***
(0.000)
-0.180***
(0.000)
-0.178***
(0.000)
-0.173***
(0.000)
-0.175***
(0.000)
Underwriter ranking
-0.001
(0.890)
-0.002
(0.795)
-0.002
(0.722)
-0.002
(0.743)
0.012
(0.621)
Syndicate size
-0.001
(0.664)
-0.001
(0.548)
-0.001
(0.509)
-0.001
(0.524)
-0.001
(0.415)
Price revision
0.063***
(0.001)
0.063***
(0.001)
0.056***
(0.005)
0.056***
(0.005)
0.052**
(0.012)
Firm age
0.033***
(0.008)
0.036**
(0.014)
0.035***
(0.010)
0.036***
(0.009)
0.034
(0.011)
Share overhang
-0.054
(0.294)
-0.051
(0.306)
-0.066
(0.211)
-0.062
(0.243)
-0.071
(0.179)
Days between S-1 and 424
-0.019
(0.120)
-0.021*
(0.084)
-0.023*
(0.055)
-0.023*
(0.055)
-0.023*
(0.054)
Constant
0.058
(0.258)
0.045
(0.333)
0.073
(0.154)
0.068
(0.190)
0.065
(0.193)
197
0.325
9.77
0.000
197
0.315
10.44
0.000
197
0.322
9.27
0.000
197
0.322
8.75
0.000
197
0.308
97.43
0.000
Industry return
Firm and offer characteristics
Promotion costs
Number of observations
Adj R2/ R2
F-value /Wald chi2
(p-value)
Notes: This table provides the estimates of the ordinary least squares (OLS) and two-stage least squares (2SLS)
regressions. The sample consists of 197 venture-backed biotechnology IPOs in the years 2003-2014. The
dependent variable, wealth losses per old share, is computed as the amount of money left on the table relative to
preexisting equity value. The independent variables are defined in Table 2. Standard errors are adjusted for time
clustering by assuming that observations are independent for companies at different points in time, but not
necessarily for companies which go public in the same month. They are more conservative than White (1980)
- 37 -
standard errors. p-values are displayed in parentheses. *, **, and *** indicate values that are significantly
different from zero at the 10%, 5%, and 1% levels, respectively.
5.3 Actual VC participation
In this section, we examine the actual subscription rates in IPOs. Although venture capitalists
have reputational capital at stake, as they are repeat players in the IPO market, an alternative
explanation is that of false signaling. Because indications of interest in purchasing shares of
common stock in the initial public offering are not binding agreements or commitments to
purchase, investors could determine to purchase more, less or no shares in the offering. To
control for potential false signaling, we examine filings in the post-IPO period (primarily 10K and DEF 14A filings available at www.sec.gov) which in most cases contain information
regarding actual take-up levels and compare them with the S-1/A filings and Form 424 (final
IPO prospectus).
Data on subscription pre-commitments becomes generally available in the first amended S-1
filing (S-1/A) following the S-1 filing. The same amended offering typically contains more
detailed information regarding the price range and the number of shares offered in the
offering. In this study, the proportion of initial public offerings with pre-commitments is 65.5
percent. Table 12 shows total subscription pre-commitments in dollars and as percentages of
shares issued in the S-1/A- and 424 filings and actual take-up levels.
Table 12. Subscription precommitments and actual subscription data
Panel A. S-1/A and 424B4 information
S-1/A
Total precommited
amount ($1,622 million)
424B4
Total precommited
amount ($2,051 million)
Mean
Median
Mean
Median
Issue size ($ millions)
71.10
65.07
62.33
55.00
Fraction of total issue (%)
25.27
21.96
26.85
25.00
Amount per issue ($ million)
18.03
15.00
15.90
Number of observations
90
14.80
129
Panel B. Actual subscription levels
Fraction of shares purchased (%)
Mean
Median
Min
Max
24.87
23.04
4.33
71.84
Notes: This table reports the mean (median) percentage of the share issue pre-committed to be subscribed (Panel
A) and the actual subscription levels by US venture-backed biotechnology firms during the 2013-2014 period.
Data on subscription precommitments is collected from S-1/A filings and IPO prospectuses (424). Data on actual
take-up levels are primarily obtained from SEC-filings (such as 10-K and DEF 14A) in the post-IPO period. In
- 38 -
some instances, we use SC 13G filings by individual investors and compare the number of shares with
information from the IPO prospectus. It is worth noting that it is the responsibility of the investor according to
SEC regulations to file a 13G to file a SC 13G within 45 days of the end of the quarter, and not all investors are
required to file. In these latter instances, we confirm the data through communication with the firms.
The mean (median) subscription pre-commitment in the S-1/A filing is 25.3 (22.0) percent
(see Panel A, Table 12). In comparison, the mean (median) subscription pre-commitments
increase in the 424B4 filing to 26.9 percent (25.0 percent). However, the subscription levels
in dollar amount decreases from an average (median) of $18.0 ($15.0) million to $15.9
($14.8) million due to the decrease in the size of the offerings. The number of IPOs with
subscription precommitments increases from 90 to 129 from the S-!/A filing to the 424B4
filing. Panel B, Table 12, displays actual subscription levels. The mean (median) actual
subscription levels is 24.9 (23.0) percent, which indicate that venture capitalists do not engage
in false signaling. In the extreme case, preexisting investors purchase 71.8 percent of the
shares offered in the IPO, which contrasts the view of IPOs as exit events.
6. Conclusions
One of the key issues in venture capital finance is the exiting process (cf. Gompers and
Lerner, 2000). Venture capitalists’ unique skill is the guidance of new entrepreneurial
ventures in early stages of growth. The main conception of venture capital is that once a
portfolio company becomes mature they will leave the firm and redeploy its resources
elsewhere, where the marginal productivity will be higher (Barry et al., 1990). The existing
literature on venture capital exits has mainly treated the IPO itself as an exit event (e.g.,
Cumming, 2008) although venture capitalists rarely sell their shares at the time of the IPO
(e.g. Gompers and Lerner, 1998).
This paper examines the certification role of preexisting investors that participate in the IPO.
We find that subscription precommitments by preexisting venture capitalists are unassociated
with IPO underpricing, which may suggest that at least part of the quality signal through their
reputational and significant preexisting shareholdings may already be incorporated into the
offer price. In contrast, we find that the participation of corporate partners is negatively
associated with underpricing, which lends support to the certification hypothesis. This is
consistent with the Nicholson et al. (2005), who suggest that if outside investors have less
information than pharmaceutical firms regarding the likely success of a biotech firm’s
- 39 -
products, then by doing a deal with a pharmaceutical firm, a biotech firm can signal its quality
to financial markets.
Our analysis also sheds light on the supporting role of preexisting investors, and especially
preexisting venture capitalists, when there is a lower demand for the firm’s shares. Revisions
in the offer price are negatively associated with venture capital participation, but unassociated
with corporate participation. Preexisting investors precommits to purchase an average amount
of $18.0 million in the first amended S-1 filing. The number of IPOs with subscription
precommitments increases from 46 percent in the first amended S-1 filing to 65 percent in the
final prospectus, although the amount per issue decreases to an average of $15.9 million in the
final prospectus. Our Tobit regression also supports this result.
We find no significant association between participation, our ex ante measure of uncertainty,
and stock return volatility in the post-IPO period. Similar to Barry et al. (1990) and Lin and
Smith (1994) this study documents the continuing role of venture capitalists as and
shareholders in the years after going public, which is consistent with the certification
hypothesis. This paper contributes to the IPO literature by providing additional and detailed
information about the role of venture capitalists in bringing their portfolio firms to the public
market.
Although retention of ownership provides both a signal of value and an ongoing commitment
to monitor, the purchase of shares in the IPO has two main consequences. First, venture
capitalists allocate a significant amount of resources to later-stage investments, where the
return from continuing to monitor the company may be below opportunity cost. The
implication may be an emerging innovation and funding gap in early stage R&D, i.e. less
capital is available for reinvesting in new innovative ventures. Second, Paeglis and Veeren
(2013) find that the speed at which VCs exit after its IPO depend on the firms post-exit
ownership structure and the liquidity of its stock. Going public with a significant venture
capital participation in the IPO is likely to increase the post-IPO ownership and decrease the
free float of the stock, and thereby, delay the exit and the realization of the capital gains from
the investments. By the end of the day, investor returns are critical for the entire asset class
and its ability to attract future funding22.
22
In a recent paper, Harris et al. (2014) document that venture capital funds outperformed public equities in the
1990s, but underperformed in the 2000s, whereas buyout funds on average have outperformed public equities in
both periods.
- 40 -
Participation by preexisting investors in the IPO and the allocation of capital to later-stage
investments is also consistent with the growing trend of venture investments in public equity
(VIPE) in the past years (Chaplinsky and Haushalter, 2012). Further research could examine
the hazard of being acquired and subscription precommitments by corporate partners, the role
and participation of venture capital in subsequent financing rounds and if venture capital
investors continue to support their portfolio firms. Future research on venture capital and the
role of venture capitalists and corporate partners in the post-IPO period seems promising.
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