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University of Nebraska-Lincoln College of Business Administration

The Certification Role of Large Block Shareholders in Initial Public Offerings: The Case ofVenture CapitalistsAuthor(s): Timothy H. LinReviewed work(s):Source: Quarterly Journal of Business and Economics, Vol. 35, No. 2 (Spring, 1996), pp. 55-65Published by: University of Nebraska-Lincoln College of Business AdministrationStable URL: http://www.jstor.org/stable/40473183 .

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The CertificationRole of Large BlockShareholders in Initial Public Offerings:The Case of VentureCapitalistsTimothy H. LinNationalChungChengUniversity

Thispaper providesevidence or thecertificationole of large block share-holders in the initialpublic offeringrocess. I use an exhaustive et of venturecapital-backednitial ublicofferingss an example.Thepresenceofventureapitalfirms n an issuing irm erves o reduce heunderpricingnd underwritingosts. naddition,ead venture apitalist re-IPO shareholdings associatednegativelywithinitialreturn. onsistent ith hecertificationypothesis,hequalityoftheirrepu-tation s recognized ythecapitalmarkethroughowerunderpricingnd underwrit-ing spread.INTRODUCTIONThere sconsiderableheoryndevidence hat nitial ublic fferingsIPOs), on aver-age,experience ositivenitial eturnsndthat hemarket eactsnegativelyo seasonedequity fferings.his kind fmarket eactions a directmplicationf Leland andPyle(1977) andMyers ndMajluf 1984). AlthoughWelch 1989), Allenand Faulhaber(1989),andGrinblattndHwang1989)havepresentedignalingmodels hat redicthatintrinsicallyigher alue firmsanconvey heir rivatenformationhroughPO under-pricingodetermimickingy owervaluefirms,here re several easons hatmake thefirstartyctions uspect. orexample,Gale andStiglitz1989) showthat nitial ublicofferingignalingmodelsbreak ownwhen ssuers re allowedto sellequitymore hanonce. fpotentialnvestorsannot istinguishmong he uality f newequity fferingsandplaceanaverage alueon all issues, he emons roblemescribedyAkerlof1970)occurs.To provideneffectiveignalingmechanismor nequity ffering,n issuer an hireor lease thereputationrom third arty pecialist. ooth nd Smith1986) model thecertificationoleprovided y nvestmentankers o reduce nformationsymmetrynnewequity fferings.eAngelo 1981),Beatty1989),Titmannd Trueman1986),JohnsonandMiller1988),andCarterndManaster1990)examine ow uditorsnd underwritershelpresolvetheasymmetricnformationnherentnthe PO process.Megginson ndWeiss 1991) find hat he nitial eturnoventure-capitalVC)-backedPOs is lower hanthat f non-VC-backedPOs. Their vidence uggests hat hepresence flargeblockshareholders ayprovide complemento underwritereputationnreducingPO uncer-tainty.n addition, arry,Muscarella, eavy, ndVetsuypens1990) show that enturecapitalists pecializetheir nvestmentsnfirms oprovide ntensemonitoringervice.Theirmonitoringunctionsrerecognized ythemarkethroughowerunderpricing.Moreover, ompers1995a) findshat hemonitoringunctionrovided yventureapi-talists s valuable bothto investorsnd entrepreneurialompanies. distinguishhisstudy romhe arlierworks y focusingn VC reputation.singthe quallyweighted

550747-5535/96/1300-005502.50 UniversityfNebraska-Lincoln

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56 LINvalueofstandardizedentureizeandageas a proxy or eputation,find hat PO under-writingosts are associatednegatively ithVC reputation.he evidence s consistentwith ooth ndSmith's1986)certificationypothesis.Ventureapitalistsreactive nvestorshat re nsidersntheir ortfolioompanies.Usuallythey old substantialquity ositions, erform onitoringunctions,nd serveoncompanyoards f directors.he success fa VC firmepends ot nly nthe bilityto identifynd nurturetsportfolioompanies hat relikely o be successful, utalsodepends n the bility o unwind tsequity ositiono that eturnsromntrepreneurialeffortre maximized.When portfolioompany oes public,VC firms sually layanimportantole nhelping he ompanyhoosemanagingnderwriters.1entureapital-istsmayparticipatenmeetings ith epresentativesfunderwritersnd discuss he im-ingandtermsftheoffering. ith quity tstake, entureapitalists avean incentivetotake heir ortfolioompanies ublicwhen heportfolioompanies' quity aluationsarehigh.2 hus,VC-backed POsprovide unique pportunityoexplore he ertificationroleof arge lock hareholdersnnew quityfferings.Consistent ith hefindingsfBarryt al. (1990) andMegginsonnd Weiss 1991),myresults how thatVC backing educes hemagnitudefunderpricingndthat uchbacking ignificantlyowers heunderwritingpread.naddition, find hat he evel ofIPO underpricingnd underwriterpread re associated egatively ith he evel of VCreputation.he results re consistent ith he mplicationsf the ertificationypothe-sis.THE HYPOTHESISIn their ertificationodel BoothandSmith1986) demonstrateonditions nderwhich nonsalvageable eputationanserve s an effectiveond oguaranteehe ualityof a firm. utside nvestors' illingnessopay premiumor he ertificationrovidesstream fquasi-rentshat nlywillcontinue o bepaidas long s the hirdarty oes notcheat.Thecertificationan serve s an effectiveignalfthenonsalvageableuasi-rentsgreaterhan one timewealth ransferrom alse ertification.vidence f thereputa-tional apital easoningofinancialmarketsncludes eAngelo 1981) andBeatty1989)on therole of auditor eputationnaccountingtatementertification,eatty nd Ritter(1986) on theunderwritereputationncertifyingewequity fferings,ndMegginsonandWeiss 1991) on thepresence f VC firmsnreducingPO underpricing.here restrong priori easons obelieve hat C firms ave n ncentiveoestablish/oraintaina trustworthyeputationnorder o retain ccess tothe PO market. ygrave nd Stein(1989) providevidence hatVC firmssually ake heir ortfolioompanies o themar-keton anongoing asis to unwindheirquity olding. in and Smith1995) show thatVCs arerepeat layersnthe ssuingmarketnd that eputable Cs tend o avoidsellingoverpricedssues to maintainheir eputation.n this tudy,6 VC firms admore han1This s becauseof theirloserelations ithnvestmentanks.Venture conomics1987) reportshatmong76 venture apitalfirms urveyed, 1 percentre affiliated ithfinancial orporations,ncluding anks,investmentanks, nd nsuranceompanies.2Lerner1994) showsthatVC-backed irms o publicwhen quity aluations rehigh, ndemploy rivatefinancing henvaluesare ower.

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QJBE, SPRING 19%, VOL. 35, NO. 2 57sixportfolioirms o publicfrom 979 to 1990.Establishingeputationnablesventurecapitalistsoredeployheirntrepreneurialalentndresourcesmore rofitably.urther-more, s Megginsonnd Weiss 1991) suggest, reputationfhonestyboutthe ssuerswill enable venture apitalists o establish nduring elationships ith nstitutionalinvestors hoarevitallymportants investorsnVC firms nd as purchasersf sharesin IPOs.The certificationypothesisescribed boveyields our establemplications.irst,becauseoutsidersackreliablenformationbout n issuer'svalue ndgrowthpportuni-ties, PO underpricingsrequireds a compensationor heuncertainty,s suggestedyRock 1986) andBeattynd Ritter1986). IfthepresencefVC firms anprovide redi-ble informationbout he uality f an ssue, he ompensationo nvestors illbe lowerfor ssueswithVC-backinghan or ssueswithoutC-backing.econd,becauseventurecapitalistsreproficientt taking irmsublic, heirxperiencenthe PO processmayhelptheir ortfolio ompanies hoose underwritershat an reducethe ssuing osts.Hence, hemagnitudefunderwritingpreadhould elower orVC-backed POs than ornon-VC-backedPOs. Third, romhe ertificationypothesis,hepenaltyffalsely ig-naling s more ostly or reputableertifierhan or lessreputablene.This mpliesthat eputable C firmsre ess ikely o cheat ecauseof the ondingmechanismesult-ingfromhepenalty. ational nvestorsrewilling opaymorefor ompanies roughtto market y reputableVC firms.Accordingly,POs backedby reputableVC firmsshouldhave less underpricinghan POs backedby less reputableVC firms. ourth,James1992) argues hat hegreaterheuncertaintyoncerningirm alue, hegreaterherisk orne yunderwriters.herefore,positive elationsexpected etweenpreads ndmeasures funcertaintyoncerningssuing irmalue.Turningames's rgumentround,ifVC reputationan reduce n issuer'suncertainty,POs backedby reputable C firmsshould ave ower nderwriterpread hanPOsbacked y essreputable C firms.DATATo identifyPOs backedbyVC firms,follow hedatacollection rocess fBarry,Muscarella, eavy, ndVetsuypens1990). Informationf VC-backed POs is collectedfrom he nnualreportssues of Venture apitalJournalFrom1979 to 1990 VentureCapitalJournal eported51 IPOs madebycompanieshat ad receivedVC investment.Information n a VC firm'sdirectorshipnd shareholdings collected fromthe"Management"nd"PrincipalndSelling hareholders"ections fprospectuses,espec-tively. escriptivenformationntheVC firms,ncludingheir ounding ears nd sizeof funds ndermanagement,s obtained romratt' Guideto Venture apitalSources.Because ventureapitalfirmseldom orrowmoney ornvestments,und izereportedbythePratt' Guidetypicallyepresentshe mount f funds aisedfrom nvestorsndmanaged ya ventureapitalfirm. o avoida survivorshipias,both urrentnd olderissuesof Pratt' Guideare used. fan IPO does nothave a VC firmisted nthePrattsGuide,theobservations notclassified s a VC-backed ssue. obtain 97 VC-backedIPOs. A sample f2,137non-VC-backedPOs ofcommon tock hat ccurred etween1979 and 1990 s identifiedsing heDirectoryfCorporate inancing nd SEC regis-

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_58 LIN_Table 1- Summary Statistics of VC-Backed and Non-VC-Backed InitialPublic Offerings (medians in parentheses)VC- Backed Non-VC- t-statistic Mann-WhitneyVariable IPOs Backed POs in Mean ZtestNumber f ssues 497 2137Offer ize1 $22.9 $26.6 1.74* 13.49***(17.3) (7.3)Offer rice $11.2 $8.6 11.02*** 10.88***(10.0) (8.0)FirmValue* $87.3 $65.0 3.79 15.98***(60.0) (20.3)Issuerage 7.5 15.0 10.97*** 1.35(5.0) (5.0)Earning erShare $1.34 $1.72 0.84 1.37(0.58) (0.67)Earning erShare Over Offer rice 10.6% 17% 1.92* 3.21***(4.8%) (6.5%)UnderwritingpreadOver Offer ize 7.4% 8.3% 14.93*** 13.44***(7.0%) (8.0%)Underwriteranking5 7.0 5.5 14.93*** 11.61***(7.5) (5.5)*Inmillionsf dollarsbDefined s theCarter nd Manaster1990) rankingfunderwriters,here indicates hehighestevel ofprestigend 0 representshe owest evel* Significantt the 10percentevel* Significantt the5 percentevel*** Significantt the 1 percenteveltered fferingtatisticsape.3 heclosing tock rice fthefirstradingate s obtainedfrom heCenter orResearchnSecurityricesdatatape.VC backing epresentsbout18.8percentfall IPOs. Consistent ith arry tal, thenumber f POs varieswidelyacross ime. heyears fexceptionallyighPO activityre1983, 1986, nd 1987.Table 1comparesharacteristicsetween C andnon-VC-backedPOs using stan-dard -testndMann-Whitney edian estSummary easures fofferize andofferricearepresentednrows2 and3,respectively.onsistent ith hefindingsfMegginsonand Weiss 1991),VC-backed POs havea largermedian fferize than hat f non-VC-backing, lthoughhepresence f several argenon-VC-backedPOs leads toa smallermean ize forVC-backed ffers.naddition,C-backedPOshave higherfferrice ndfirm alue,defined s the fferrice imes hares utstanding,han on-VC-backedirms.Rows5 through present ummarytatisticsf ssuer haracteristicsefore oingpub-lic.Consistent ith hefindingsfBarrytal (1990), PO withVC-backing as shorteryearsbefore oingpublic han on- C-backing.While arnings er harebetweenVC-backed and non-VC-backedPOs arenotsignificantlyifferent,he atter rouphas ahigher arning/offerrice atio han he ormerroup. ummary easuresfunderwritingcosts ndunderwriterrestigerepresentednrows8 and 9. Theresults eveal hatVC-backed irmsave ower nderwritingpreads,efinedsgross pread ver fferrice,ndemploymorereputable nderwriters,here he nderwritereputations defined s the3Theregisteredfferingtatisticsapewas discontinuedythe EC at the nd of1988.

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QJBE, PRING 996,VOL.35,NO. 2 59Table 2 Weighted Least Squares Regressions of Initial Return andUnderwriting pread Against the Log of OfferSize, Age of the IssuingFirm, UnderwriterRanking, and Whether an Issue is VC-Backed. DummyEquals 1 if an Issue Is Backed by VC Firms,0 OtherwisePanelA: Correlation atrix f theExplanatoryariablep-value nparentheses).Log of Offer ize Issuer'sAge Underwriteranking DummyLog ofOffer ize 1.000(0.000)Issuer's Age -0.022 1.000(0.266) (0.000)Underwriteranking 0.671 0.005 1.000(0.001) (0.817) (0.000)Dummy 0.203 -0.133 0.253 1.000(0.001) (0.001) (0.001) (0.000)Panel B: Regression esultst-statisticsnparentheses). DependentVariableIndependent ariable InitialReturn%) UnderwritingpreadOverOffer rice %)Intercept 18.20 14.67(3.49***) (48.02***)Log of Offer ize -0.35 -0.58(-0.53) (-13.86***)Issuer'sAge -5.82E-2 -2.37E-3(-2.83***) (-1.57)Underwriterankinga -1 05 -0.22(-2.86***) (-12.25***)Dummy -1.13 -0.157 (-1.27) (-3.59***)Adjusted 2 0.06 0.59N 2,180 2,158a Defined s theCarter nd Manaster1990) rankingfunderwriters,here indicates hehighestevel ofprestigend0 representshe owest evelSignificantt the 1percentevel

Carter nd Manaster 1990) ranking.4he findings consistent ithMegginson ndWeiss' (1991) reporthatventureapitalistsrecapableofhelping ntrepreneursnattractinguality nderwriters.RESULTS AND INTERPRETATIONSTo examine he ertificationoleofVC firms,nitial eturnndunderwritingpreadareregressed gainst ogof offerize,age of the ssuing irm,nderwriteranking,ndwhetherhe ssue is VC-backed.The dummy quals one ifan issue is backedbyVCfirms,erootherwise.Cross-ectional ests f the ertificationypothesisrereportednTables 2 and 3.Significanceevels recomputedsing heWhite1980)correctionor eteroskedasticity.PanelA of Table2 reportshe orrelation atrix f the ndependentariables. ffer izeis correlatedositively ith nderwriterankingnd the resencef ventureapital.Mostimportantly,hepresence fventureapitalistss associatedwithmoreprestige nder-writers. olumn of PanelB inTable2 reportsheweightedeast quares esultswhen4 In thesample2,181 (82.8 percent f thetotal) POs' lead underwritersre in theCarter nd Manaster'(1990) listing.f the eadunderwriters not isted ntheCarternd Manaster' listing,use therankingf thecomanaging nderwriters theproxy orunderwriterrestige.

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60 LINTable 3 Weighted Least Squares Regressions of Initial Return andUnderwriting pread Against the Log of OfferSize, Age of the IssuingFirm, Lead VC Pre-lPO Shareholding, UnderwriterRanking, and VC Rep-utation IndicatorPanelA: Correlation atrix ftheExplanatoryariablesp-valuenparentheses).Log of Offer VC Pre-IPO UnderwriterVC ReputationSize Issuer'sAge Shareholding Ranking IndicatorLog ofOffer ize 1.000(0.000)Issuer'sAge 0.082 1.000(0.067) (0.000)VC Pre-IPO hareholding -0.029 0.657 1.000(0.510) (0.144) (0.000)Underwriteranking 0.588 0.101 -0.862 1.000(0.001) (0.025) (0.055) (0.000)VC Reputationndicator 0.165 0.011 0.114 0.169 1.000(0.001) (0.799) (0.011) (0.001) (0.000)Panel B: Regression esultst-statisticsnparentheses) DependentVariableUnderwritingSpreadOverIndependent ariable InitialReturn%) Offer rice %) IssuingCostc %)Intercept -17.57 13.29 -4.20(-1.84*) (34.43***) (-0.44)Log ofOffer ize 3.77 -0.46 3.30(3.54***) (-9.63***) (3.03***)YearsFrom ncorporationoOfferingate -3.02E-2 -2.35E-3 -0.034

(-0.67) (-1.35) (-0.49)LeadVC Pre-IPO hareholding -0.12 -2.37E-3 -0.117(-2.94***) (-0.84) (-2.25**)Underwriteranking* -1.29 -0.20 -1.48(-3.36***) (-5.44***) (-3.91***)VC Reputationndicator0 -1.61 -7.78E-2 -1.71(-1.97**) (-2.09**) (-1.99**)Adjusted 2 0.08 0.45 0.08N 496 492 492a Defined s theCarter ndManaster1990) rankingfunderwriters,here indicates hehighestevel ofprestigend 0 representshe owest evelb The VC reputationndicators defined s the qually- eightedmeasures fVC firm's ge andportfoliosize. The ndicator an be expresseds:.VCi .. indicatora- 1fsiZfr-Sz AGE,-AGE.VCi reputation. indicatora- = j ^ STD^ + AGE,-STDA0E / where:

SIZE = PortfolioizeofVC firm;SIZE = Mean ofVC firms' ortfolioizes;STD^ = Cross-sectionaltandard eviationf VC portfolioize;AGE, = AgeofVC firmAGE = MeanofVC firms'ges;andSTD^e = Cross-sectionaltandardeviationf VC age.c Issuing ost s defined s the ummationfunderpricingndunderwriterpread* Significantt the10percentevel** Significantt the percentevel*** Significanttthe1percentevel

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QJBE, PRING 9%,VOL.35,NO.2 61initial eturns thedependent ariable.While Ritter1984) shows a negative elationbetween nitial eturnndofferize,the esultsnthis tudy evealnosignificantelationbetween hem. he coefficientn the ssuing irm'sge is negativendstatisticallyig-nificant. heevidence s consistent ithRitter'(1991) argumenthat ld firms re essriskywhich esultsn ower nderpricing.onsistent ith ooth nd Smith's 1986) cer-tificationypothesis,he nitial eturns associated egatively ith nderwriteranking.In addition,whilethecoefficientn thedummy ariable s negative,we are unable tomakea strong ttributionrom hedummy ecause of itshigh collinearity iththeunderwriterrestige.The secondregression,hown n column2, replacesthe nitialreturnwith theunderwritingpread.Consistent ith hefindingsfBhagatand Frost 1986), James(1992),andothers, negativeelation xists etween heunderwriterpread nd the ffersize. While he oefficientn the ssuer's ge isnegative,he - alue s not ignificanttconventionalevels. also find hat he oefficientn theunderwriterankings relatedinversely ith heunderwriterpread.Moreover,he oefficientn the ummyariable snegativendsignificantt the1percentevel.The evidencemplies hat he xistence fVC firms an reduce ssuing osts. The estimates resentedn Table 2 suggest hatunderwriterrestiges themostmportanteterminantf nitial eturnndunderwritingspread.Thepresence fVC firms rovides complementf underwritereputationnlowerunderpricingndunderwritingosts, ontrollingor heeffectsfoffer ize andissuer ge.TheregressionesultsnTable 3 highlightherelation etweenVC reputationndunderpricing.o reflect heVC reputation,lead VC firm'sge,whichs defineds theofferingate minuses hefoundingear f theVC firm,nd the mount f fund ndermanagementre chosen s proxies.5 he rationales as follows. irst, he onger VCfirm as been nbusiness, he ess uncertaintyhemarket aces about whether heVCfirms likely o cheat bout n issuer'svalue.A longer perating istorylso maypro-videmarketarticipantsithnformationoncerningC managerialnvestment-unwind-ingdecisions. his additionalnformationay llow nvestorsomarginallyeduce heirestimate f ex anteuncertainty.ence, he onger VC firm'sge,themore redible heinformationt conveysabout the issuer.Second,venture apitalistsmust convinceinvestorsindividuals,orporations,undmanagers, inancialnstitutions,tc.)of theirexpertisend theirbilityonurtureewgrowingompanieso attractesources. ccord-ingly,he mountf fundmay erve s a proxy orVC expertisenthe ndustry.naddi-tion,managing largeportfoliomplies hat ventureapitalfirms involvednmanyemergingompaniesndmayneed POs to exit hose ompanies. requencyn nvolvingIPOs increases he ncentive orventureapitalistsoprotectheir eputationndpre-serves heir ption o sell shares nfuturePOs. The amount f fund lso representsproxy or hepenaltyfcheating.he argerhe ize of the und,hemore heres to ose5AppendixA summarizesead VC firms' wnerships,ortfolioizes,andages. Iftwo or moreVC firms rein the ame PO firm, choose theVC firm hat as the argest hareholdings the ead. If two or moreVCfirms avethe ameamount fshareholdingn the ame PO firm,heone with irectorshipf the ssuer schosen. Our classification f lead ventureapitalist ollowsBarry t al (1990), but differs romGompers(1995b).Gompers efineshe eadventureapitalists thefirmhat as been on theboard he ongest s theleadventureapitalist.

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62 LINifventureapitalistsonvey alselynformationbout n issuer.6 thereforeonstructheVC reputationndicatorsing he quallyweighted easures f VC firmgeandportfoliosize. Thereputationndicatorscalculated s:

. . ,. 1 fsiZEj - SIZE AGEj-G^VQ reputationindicator,. = - - =r + - ==r ,y MDsize milage jwhere:

SIZEi = Portfolioize of VC firm;SIZE = MeanofVC firms' ortfolioizes;STDsize = Cross-sectionaltandardeviationfVC portfolioize;AGEj = Ageof VC firmAGE = Mean of VC firms'ges;andSTDage = Cross-sectionaltandardeviationfVC age.Initial eturns regressedgainst heVC reputationndicatorndfour ontrol ari-ables: the ogof offerize,the ge of the ssuing irm,hepre-IPO hareholdingf the

lead VC firm,nd theunderwriteranking. anelA ofTable 3 reportshecorrelationmatrix fthe ndependentariables. ffer ize is associated ositively ith othunder-writernd ventureapital eputations.naddition,hehigherhe entureapital eputationis, themoreprestige he underwriteras. Panel B of Table 3 reports heregressionresults. olumn1 indicates hat heunderpricings related ositivelyo theoffer ize,consistentwiththefindings f Barry,Muscarella,Peavy,and Vetsuypens1990).Althoughhecoefficientn the ssuer's ge is negative,hecomputed -statistics notsignificantt conventionalevels. naddition,he nitial eturns related egatively iththe ead VC firm's re-IPO hareholding.hisevidence uggestshat ighVC sharehold-ingconveys positive ignal bout n issuer's irm alue.The resultsmply hat,eterisparibus, increasing lead VC firm's re-IPO hareholdingy 1 percent,n average,resultsnan additional eductionn0.12percentf PO underpricing.oreover,onsis-tentwith hecertificationypothesis,he nitial eturns associated nversely ith heunderwriterankingt the1percentignificantevel.Last, heunderpricings related eg-ativelywith heVC reputationndicator. he evidence s consistent ithBarry,Mus-carella,Peavy, ndVetsuypens's1990) argumenthat ualityVC firms an reduce POunderpricing.Incolumn initial eturnsreplacedwith nderwritingpread. he results howthatmost fthe xplanatoryariables opredictheunderwritingpread renegative. onsis-tentwith he eportedesults fJames1992),theunderwriterpreads associatednega-tivelywith fferize.Althoughhe oefficientsn the ssuer's geand the eadVC firm'spre-IPO hareholdingrenegative,heiromputed-statisticsre not ignificantt con-6I thank nanonymousefereeor ointinghis ut.

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QJBE, PRING 996,VOL.35,NO. 2 63^ventionalevels.While he nvestmentankprestigend theVC reputationndicatorrehighlyorrelated,he oefficientsn both egressorsrenegativendstatisticallyignifi-cant t the percentevel.Incolumn issuing ost,defineds the ummationfunderpricingnd underwriterspread,s used as thedependentariable. onsistent ith heprediction,C reputationandpre-IPO hareholdingsre related egatively ith ssuing ost.The results uggestthat,eteris aribus, ncreasing lead VC firm's re-IPO hareholdingy1 percent,naverage, esultsnan additional eductionn$420,650 n ssuing osts.7The evidencepresentednTables2 and 3 revealsthatnewequity ssueswithVCinvestmentsre metwith lower nderpricingndunderwritingpread. his evidence sconsistent ith hefindingsfBarryt al (1990) andMegginsonndWeiss 1991). Theresults re also consistent ith henotion fthecertificationypothesisiscussedbyBooth nd Smith1986).CONCLUSIONThispaper nvestigatesPO underpricingorfirmswith ndwithout C backing.Thispaperalso examines herelation etweenVC reputationndunderwriterpread.There re two contributionsf this tudy. irst, hispaperdocumentshatVC backingreduces hemean nd median egree f PO underpricingnd that uchbacking ignifi-cantlyowers nderwritingpread harged y nvestmentanks. upports foundnboththebivariate -testndthe ross-sectionalegressions.his s consistent ith henotionsthat hepresence fa VC firman be a partialubstituteor nd a complemento the er-tificationrovided yinvestmentankers. econd,ventureapitalists,s largeblockshareholders,lay n importantole ncertifyinghevalueofa newequity ffering.hequality f their eputationrovidesncrementalnformationot ignaledbytheunder-writerlone. Consistent ith he ertificationypothesis,C reputations able toreduceIPO underpricingndunderwritingosts.

7The average ssuing ost of VC-backed POs is 15.7percent f theoffer ize. That s, the verage ssuingcost s equivalento$3,595,300.

REFERENCES1. Akerlof, M The Market or Lemons':Quality nd the MarketMechanism," uarterly ournal fEconomics, 4 (1970),pp.488-500.2. Allen,F., and G. Faulhaber, Signaling y Underpricingn the PO Market," ournal fFinancialEconomics, 3 (1989),pp.303-323.

3. Bhagat,S., and P. Frost, IssuingCosts to Existing hareholdersn Competitivend NegotiatedUnderwrittenublicUtility quity ffers,"ournalfFinancialEconomics, 5 1986),pp.213-232.4. Barry, , C. Muscarella, .Peavy II, andM. Vetsuypens,The Role of Venture apital ntheCre-ation f PublicCompany," ournal fFinancialEconomics, 7 (1990),pp.447-471.5. Beatty,R., and J.Ritter,Investmentanking,ReputationndtheUnderpricingf Initial PublicOfferings,"ournal fFinancialEconomics, 5 1986),pp.213-232.6. Beatty, ., "Auditor eputationnd thePricing f nitial ublicOfferings,"heAccounting eview,64 (1989),pp.693-709.7. Booth,J., nd R. Smith,CapitalRaising,Underwritingnd theCertificationypothesis,"ournal fFinancialEconomics, 5 1986),pp.261-281.

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64 LIN8. Bygrave,W., andM. Stein, A Timeto Buyand a Timeto Sell: A Study f 77 Venture apital

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QJBE, PRING 9%,VOL.35,NO.2 65APPENDIX A- SUMMARY STATISTICS OF LEAD VC PRE-IPOSHARE HOLDING AND PROXY FOR VC REPUTATIONStandardVariables Mean Deviation

Lead VC Finn's Pre-IPO hareholding 17.3% 13.4%Amount fFundUnderManagementythe ead VC Finna 168.73 215.18Ageof the ead VC Firm efore POs 12.82 9.03a Inmillions fdollars.