Venture Capitalist Participation and The Performance of

EMEMAR-00468; No of Pages 20
Emerging Markets Review xxx (2016) xxx–xxx
Contents lists available at ScienceDirect
Emerging Markets Review

journal homepage: www.elsevier.com/locate/emr
Venture capitalist participation and the

performance of Chinese IPOs☆
Isaac Otchere a,⁎, Anna P.I. Vong b,⁎
a
Sprott School of Business, Carleton University, Ottawa, Canada
b
University of Macau, Macau
a r t i c l e i n f o a b s t r a c t
Article history: We examine the effects of venture capitalist participation in IPOs in

Received 6 May 2015 China and find that VC-backed firms are more underpriced than non-
Received in revised form 20 June 2016 VC firms. Both VC-backed and non-VC-backed IPOs experience long-
Accepted 25 August 2016
run underperformance; however, VC-backed IPOs perform significantly
Available online xxxx
better. The higher level of underpricing and cost of going public for the
VC-backed firms are consistent with the monitoring role of the VC.
JEL classification: Finally, the fact that VC reputation is associated with lower underpricing
G24
is consistent with the reputational capital theory, which asserts that
G34
reputable VCs use their expertise and experience to minimize
Keywords: underpricing in order to preserve their reputational capital.
Venture capital
© 2016 Elsevier B.V. All rights reserved.
Initial public offering
Structural power
China
Reputational capital
1. Introduction
The ongoing economic reforms in China have transformed the economy from complete reliance on state-
owned enterprises to a mixed economy in which private enterprises play an important role both in promoting
economic growth and creating employment opportunities. The country has achieved tremendous growth of
8% per annum since 1980. China has overtaken Japan to become the world's second-largest economy (IMF,
2010). This performance, which has made the country an economic powerhouse, is reflected in sentiments
expressed by James Wolfensohn, a former World Bank President, who once said that the Chinese have
☆ We thank two anonymous referees for their helpful comments. In addition, we are grateful to the discussant and participants at the
2012 Securities and Financial Markets in Taiwan and those at the 2012 World Finance conference in Shanghai for their comments. All re-
maining errors are ours.
⁎ Corresponding authors.
E-mail addresses: isaac_otchere@carleton.ca (I. Otchere), annavong@umac.mo (A.P.I. Vong).
http://dx.doi.org/10.1016/j.ememar.2016.08.010
1566-0141 © 2016 Elsevier B.V. All rights reserved.
Please cite this article as: Otchere, I., Vong, A.P.I., Venture capitalist participation and the performance of
Chinese IPOs, Emerg. Mark. Rev. (2016), http://dx.doi.org/10.1016/j.ememar.2016.08.010
2 I. Otchere, A.P.I. Vong / Emerging Markets Review xxx (2016) xxx–xxx
accomplished in only 20 years what other countries would take two centuries to achieve. Since the late 1990s,
the government has lifted several legal and economic barriers that hinder private sector growth.1 The private
sector has expanded and has played an important role in the country's rapid economic development. The
number of private businesses has grown from 3 million in 2004 to nearly 52 million in 2011.2
Despite these efforts, Ge and Qiu (2007) note that private firms have been discriminated against in the
formal loan market. The difficulty of obtaining bank loans has driven many private businesses in China, pri-
marily small- and medium-sized enterprises (SMEs), to seek alternative sources of financing. Long-term
equity financing from venture capitalists has become an important and growing source of long-term financing
for Chinese companies. According to the China Venture Capital Research Institute (CACRI), the value of venture
capital in China grew from US$4.76 billion in 2003 to US$36.67 billion in 2008.
Venture capitalists provide their portfolio companies the value-added services ranging from coaching,
guidance, and networking for strategic alliances, to attracting further capital (Bygrave and Timmons, 1992).
In addition, by retaining a significant ownership position after the investee firms go public, VCs can continue
their monitoring role, which further accelerates the growth and performance of the firms. Extant literature
however shows that VC activities are practiced in a markedly different way in China than in the US. Bruton
and Ahlstrom (2003) and Ahlstrom et al. (2007) argue that the institutional environment in China is different
enough to make the practice of venture capital different from that of the West. For example, weak investor
protection enforcement and poor corporate governance in China could reduce VC firms' incentives to act in
the interests of investors (Bruton and Ahlstrom, 2003; Lu et al., 2012; Wright et al., 2002). The institutional
differences can lead to different underpricing and long run performance outcomes. Also, the literature
shows that different characteristics of VCs affect the investee firms' performance and that entrepreneurial
firms chose specific VCs in order to signal their quality and lower the information asymmetries between
the investee firms and market participants (Cumming et al., 2006; Hsu, 2004). Given the foregoing findings,
we examine whether VC backed IPOs exhibit lower levels of underpricing, and more importantly from
the perspective of the contribution of this paper, whether VC characteristics influence underpricing and
long-run performance in China.
This study aims to shed light on the impact of VC participation on the short- and long-term financial
performance of the investee firms. The analysis of the impact of VC participation in investee firms in China
not only provides insights for practitioners and policy makers who have continuously amended and improved
the legislation to support the development of the VC industry in China, but also it extends the VC literature to a
jurisdiction beyond the U.S. where the value-added potential of VCs has been widely acknowledged. We thus
provide out of sample evidence on a phenomenon that has been documented for the US market or other
developed countries.
Our results are summarized as follows. First, we find that both VC-backed and non-VC-backed firms in
China go public around the same age. This finding contrasts with that of Megginson and Weiss (1991) who
find that VC-backed IPOs go public at a significantly early stage of their life cycle than non-VC-backed IPOs.
Second, the average investment duration of venture capitalists in their investee firms is 2.7 years in China.
This is longer than the 2.1 years reported for Singapore by Wang et al. (2003) but is comparable to what
Barry et al. (1990) have documented for the US. Third, consistent with prior literature, we find that in
China both VC-backed and non-VC-backed IPOs are underpriced but VC-backed IPOs are more underpriced
than non-VC-backed firms. While this finding is contrary to those of Megginson and Weiss (1991), Barry
et al. (1990) and Gompers (1996) who find that VC-backed IPOs were less underpriced than non-VC backed
IPOs, it is consistent with more recent studies, including Francis and Hasan (2001), Lee and Wahal (2004),
among others for the US, Arikawa and Imadeddine (2010) for Japan, Da Silva et al. (2003) for Australia,
Tykvova and Walz (2007) and Elston and Yang (2010) for Germany that find that VC-backed IPOs realize
higher initial returns than non-VC-backed IPOs.
Fourth, both VC-backed and non-VC-backed IPOs in China underperform in the long run. However,
VC-backed firms' after-market performance is better than that of non-VC-backed firms but only for the first
1
According to Firth et al. (2009), during the 15th Congress of the Chinese Communist Party in 1997, approval was granted to banks to
lend to private businesses, and to protect private property rights.
2
‘China's growth: Planning or Private Enterprise?’ Library of Economics and Liberty, August, 2012.
I. Otchere, A.P.I. Vong / Emerging Markets Review xxx (2016) xxx–xxx 3
year after the IPO, a result that is consistent with that of Johan (2010).3 Our finding that the long-run
performance of VC-backed IPOs is better than that of non-VC-backed IPOs, coupled with the finding that
the level of underpricing is higher for the VC-backed firms is consistent with the monitoring role rather
than the certification role of VCs in China.
Having documented the level of underpricing and long-run underperformance of the sample firms, we
focus on the VC-backed firms and examine the effects of VC reputation and other governance characteristics
on the investee firms' performance. We find that VC reputation is associated with lower underpricing,
suggesting that reputable and presumably more experienced VCs use their expertise and influence to reduce
underpricing. This finding is consistent with the reputational capital theory, which posits that VCs with much
reputational capital at stake use their expertise and experience to minimize underpricing to preserve their
reputational capital. Consistent with the signaling hypothesis, we find that greater VC and CEO holdings
(controlling power), is associated with the lower the underpricing. VC investment duration is also positively
related to underpricing. In light of our finding that VC investment duration in China is longer than what has
been documented in other countries such as Singapore, our finding of a positive relationship between VC in-
vestment duration and underpricing is inconsistent with the grandstanding hypothesis of Gompers (1996)
and Lee and Wahal (2004) which suggests that VCs may grandstand by taking firms public too early and
significantly underpricing the issue.
The remainder of the paper is structured as follows: Section 2 presents a review of the relevant literature.
Section 3 describes the data and methodology. Section 4 presents the empirical findings. In Section 5, we
present further analysis of the effects of VC characteristics and other governance factors on the performance
of VC-backed IPOs. Section 6 concludes the paper.
2. Literature review and hypothesis development
Much research has been conducted on the post-issue performance of IPOs. Extant literature shows that
following the initial jump on the first trading day (leading to perceived underpricing), the aftermarket returns
of the average IPO have been sub-par. Ritter (1991) among others, documents the underpricing of IPOs. The
widespread underpricing has generated much research on why underpricing exists. In this regard, a strand
of literature has examined the role of VCs in the underpricing of IPOs and what the VCs bring to the investee
firms. The value added benefit of VC results from the certification and monitoring hypotheses. The certification
hypothesis posits that the venture capitalists, as investors in a firm going public, and because of concern for their
reputation can certify that the offering price of the issue reflects all available and relevant inside information
and that the certification provided by venture capitalists will reduce underpricing and maximize the fraction
of the proceeds of the IPO (Barry et al., 1990; Megginson and Weiss, 1991). The latter authors argue that be-
cause VCs take firms public over time, their reputation with the market and entrepreneurs will depend on
their ability to accurately price the issues. Failing this, their reputational capital will be damaged, their ability
to obtain favorable IPO prices in the future will be hampered, and the quality of their deal flow will be affected.
The authors find that the presence of a venture capitalist in the issuing firm serves to lower the cost of going
public, which in turn helps to maximize the net proceeds to the offering firm and the VC.
The screening and monitoring hypothesis asserts that VCs are able to select better quality firms to back
(screening), and they devote considerable time to monitoring the firm's management (in the pre-IPO
stage), with the consequence that the quality of firms brought public with VC backing is likely to be higher
than that of non-VC-backed firms, even if their quality at the time the VC got involved with them was similar
to that of non-VC-backed firms (Chemmanur, 2010). While Barry et al. (1990) and Megginson and Weiss
(1991) find that VC-backed IPOs are less underpriced than non-VC-backed IPOs, some relatively recent
evidence from Lee and Wahal (2004), Tykvova and Walz (2007) and Elston and Yang (2010) indicate that
VC-backed IPOs are more underpriced. Whether or not the participation of VCs in the IPO signals information
3
This finding, and the fact that IPO is not a complete exist mechanism for VCs (as they continue to maintain a large stake in the investee
firm) has important policy implications. If because of culture, VCs in China are considered as outsiders (Ahlstrom et al., 2007; Bruton and
Ahlstrom, 2003) then the benefits of their involvement will not be maximized. For the investee firms to realize significant benefits from
the involvement of VCs, entrepreneurs and managers could rethink how they perceive VCs and consider them as partners, instead of out-
siders. Policy makers can create enabling environment to improve this situation. This is all the more important given that VC backed firms
exhibit better long term performance but the superior performance dissipates a few years after the IPO.
about the quality of the investee firms has also been discussed in the literature. Some researchers have argued
that VC funding confers advantages to the investee firms because the large ownership stake of the VCs (who
may also be involved in the management of the business) reduces agency costs (Belden et al., 2010). Other
researchers have also suggested that VCs offer valuable expertise, especially in strategic planning advice to
the investee firm and that VC-backed firms grow more rapidly in scale than non-VC-backed counterparts
(Puri and Zarutskie, 2012).
Extant literature also shows that IPOs underperform in the long-run and this underperformance has in
part been attributed to underpricing in the short-run. The involvement of VCs in the firm can help improve
the firms' performance. The long-term performance of VC-backed firms could be better because if, as a result
of the certification role and reputational capital at stake VC-backed IPOs are less underpriced, then overpricing
should not be observed in the long-run (Belden et al., 2010). Thus VC-backed IPOs could perform better than
non-VC-backed IPOs. In terms of operating performance, Jain and Kini (1994) document disappointing
operating performance in the post-IPO period and attribute the results, among others, to window dressing
prior to the IPO and to opportunistic timing of the IPO. Based on Megginson and Weiss (1991), the importance
of reputational capital to the VCs would suggest that window dressing the firms' financial position would be
avoided by VC-backed firms. This evidence suggests that VC-backed IPO performance will be better than that
of the non-VC-backed IPOs.
Underpricing in China has been documented by a number of studies including Yu and Tse (2006), Chan
et al. (2004), and Chen et al. (2000). Underpricing has been attributed to winner's curse hypothesis (Yu
and Tse, 2006), information asymmetry (Yang and Zhao, 2006; Wang et al., 2006), supply and demand imbal-
ance (Chi and Padgett, 2005), and investor sentiment theory (Cao and Dong, 2006; Jiang, 2007). Prior studies
also examine the long run performance of IPOs in China and document mixed results. For example, Chi et al.
(2010) document positive long-run returns for a sample of 897 Chinese IPOs from 1996 to 2002. Liu et al.
(2012) find that IPO firms with political connections experience better long term performance as connections
bring firms preferential benefits, whereas Fan et al. (2014) find that firms with politically connected CEOs per-
form worse than comparable non-connected firms. Wang et al. (2015), Li et al. (2014) and Tong and Junarsin
(2013) find that private firms IPOs outperform state-owned listed firms in China. However, Shen et al. (2014)
find that Chinese IPOs do not underperform in the long run compared with their non-IPO counterparts.
The literature also indicates that VC activities are practiced in markedly different ways in China than in the
US. In an exploratory study based on field interviews, Bruton and Ahlstrom (2003) and Ahlstrom et al. (2007)
find that the institutional environment in China is different enough to make the practice of venture capital
different from that of the West, which can lead to different underpricing and long-run performance outcomes.
For example, whereas VCs usually conduct their monitoring activities through their membership of the firm's
board of directors (Sahlman, 1990; Sapienza, 1992), which allows them to monitor the activities of the
investee firm, Low (2002) asserts that VCs' investments in China may not necessarily guarantee a board
seat. Even when a board seat is earned, VCs will be considered outside directors, and the influence of external
directors in China is weak. This phenomenon has serious implications for monitoring, as the VCs must
cultivate a personal relationship with the entrepreneurs to gain their trust, otherwise, they will be considered
outsiders, and information needed to monitor the firm will be withheld from them (Pukthuanthong and
Walker, 2007).
While a few studies have examined the role of VC on the IPO firm's performance in China, including Guo
and Jiang (2013) and Dai et al. (2012), the results are inconsistent. For example, Dai et al. (2012) find that
foreign VCs encourage internationalization by facilitating international IPO of investee firms, while Guo and
Jiang (2013) find that VC-backed firms outperform non-VC-backed firms. Tan et al. (2013) find that Chinese
venture capitalists neither add value to their invested firms in the initial public offering (IPO) process nor im-
prove operating performance. In addition, the literature shows that different characteristics of VCs, including
reputation, duration, and holdings affect the investee firm's performance (Chahine and Goergen, 2010);
however little is known about this influence in China. Given the foregoing literature, we expect these character-
istics, which proxy for greater fund sophistication (Cumming et al., 2006) to be significantly associated with
firms' performance. We contribute to the literature by not only analyzing the role of VCs in terms of IPO
underpricing and long term performance, and therefore attempting a resolution of the debate, but more impor-
tantly we empirically examine the characteristics of VCs that affect the performance of the investee firm. By so
doing, we provide granular results on the characteristics of VCs that affect firm performance in China beyond
what is documented in extant literature. Thus, our research helps to extend our understanding of venture capital
by establishing what characteristics of VCs affect the investee firms' underpricing and long-term stock market
performance in China.
3. Data and methodology
3.1. Data
A data set consisting of 120 VC-backed IPOs listed on both the Shanghai Stock Exchange and the Shenzhen
Stock Exchange from 1990 to 2008 was obtained from the China Stock Market and the Accounting Research
Table 1
Yearly and Industry distribution of VC-backed and Non-VC-backed IPOs (1990-2008).
Panel A: Distribution of VC-backed IPO companies in China
Shenzhen Stock Exchange Shanghai Stock Exchange
Year Total Main Board SME Board Main Board
1990 1 0 0 1
1991 0 0 0 0
1992 0 0 0 0
1993 1 0 0 1
1994 1 1 0 0
1995 0 0 0 0
1996 2 1 0 1
1997 0 0 0 0
1998 0 0 0 0
1999 2 1 0 1
2000 1 1 0 0
2001 3 0 0 3
2002 4 0 0 4
2003 4 0 0 4
2004 10 0 9 1
2005 4 0 3 1
2006 13 0 11 2
2007 33 1 30 2
2008 41 0 40 1
Total 120 5 93 22
Panel B: Industry distribution of VC-backed and non-VC-backed IPOs
Industry Number of IPOs Percentage of IPOs
Agriculture 2 0.88%
Mining 4 1.75%
Food & Beverage 4 1.75%
Timber & Furnishings 2 0.88%
Paper & Printing 8 3.50%
Petrochemicals 24 10.53%
Electronics 20 8.77%
Metals & Non-metals 20 8.77%
Machinery 62 27.19%
Pharmaceuticals 16 7.44%
Other manufacturing 4 1.75%
Utility 8 3.50%
Construction 4 1.75%
IT 28 12.28%
Wholesale & retail 8 3.50%
Financials 4 1.75%
Real estate 2 0.88%
Social service 8 3.50%
Total 228 100.00%
This table presents the yearly and industry distribution of the sample firms. Panel A contains the number of venture backed IPOs listed in
China from 1991 to 2008, whereas panel B presents the industry distribution of the sample firms.
(CSMAR) database. Out of a total of 120 VC-backed companies, 98 were listed on the Shenzhen Stock
Exchange and 22 were listed on the Shanghai Stock Exchange. Of the 98 companies listed on the Shenzhen
Stock Exchange, 93 (about 95%) went public through the SME Board. In fact, as panel A of Table 1 shows, the ma-
jority of VC-backed IPO listings happened after 2004, the year the SME board was established.4 It appears from
the statistics presented in panel B that VCs in China do not invest primarily in high-technology industries; rather
they have a diversified portfolio. The majority of the VC-backed companies belong to the Machinery industry,
followed by the IT, Petrochemicals, Electronics, and Metals & Non-metals industries. These five industries ac-
count for over 67% of the sample. We follow the Megginson and Weiss (1991) matched-pair methodology to
construct a matching sample of non-VC-backed companies. For each VC-backed company, we matched with a
counterpart, an IPO company in the same industry and with a similar asset size but without VC support.
The year of listing is also used in determining the match. To be included in the study, the firm must have data
from the aforementioned source. Our final sample consists of 114 VC-backed and 114 non-VC-backed
companies.
We present the correlation matrix of the variables in panel A of Table 2. We find that VC dummy is
negatively correlated with the pre-IPO market variable and auditor reputation, which implies that VC backed
firms tend to hire low quality auditors, suggesting that with the presence of VC and their certification
role substitute for the use of high reputation auditors. However, this preliminary bivariate correlation results
should be viewed with caution, as they do not take into account the unique characteristics of the VC-backed
firms.
To examine the differences between VC-backed and non-VC-backed companies, we first present
results of univariate test of difference in issuer and transaction characteristics of the two sub-samples in
panel B of Table 2. We use parametric (t-statistics) and non-parametric (z-statistics) tests to measure
the significance level of the difference in means and medians respectively. Consistent with the findings
of Megginson and Weiss (1991) and Brav and Gompers (1997), we observe that VC-backed firms are
on average larger than non-VC-backed firms (as measured by total assets), but the difference is not statis-
tically significant. However, the proceeds realized by the VC-backed firms are significantly larger
than those realized by the non-VC-backed firms. The direct cost of going public by VC-backed firms is
significantly higher than that incurred by non-VC-backed firms. The finding of a higher flotation cost for
VC-backed firms in comparison to non-VC-backed firms is consistent with that reported for Singapore
by Wang et al. (2003). The finding of a higher flotation cost is inconsistent with the notion that due to
the certification provided by the venture capitalists, the VC-backed firms can (hire more prestigious un-
derwriters and) pay less, thus reducing the cost of going public. Both VC-backed and non-VC-backed
firms in China go public at approximately the same age. Thus, we do not find evidence of grandstanding
in China. This result contrasts with that of Megginson and Weiss (1991) who find that VC-backed firms go
public at an early stage than non-VC firms.
3.2. Methodology
We first examine the differences between VC-backed and non-VC-backed firms' post-IPO short-term per-
formance (underpricing) and long-term stock market performance to ascertain the effect of VC involvement
in IPO firms in China. We estimate underpricing as the difference between the closing price on the first trading
day and the offer price divided by the offer price. We also estimate the buy-and-hold abnormal return (BHAR)
and the cumulative abnormal return (CAR) for the sample firms three years after the IPO. The CARs are esti-
mated using the market adjusted returns method. The market return rmt is the return of either the Shanghai
Stock Exchange composite index or the Shenzhen Stock Exchange composite index, depending on the ex-
change where the firm is listed. The average market-adjusted return on a portfolio of n stocks for event
month t is the equally weighted average market-adjusted returns. The cumulative abnormal return from
event month q to event month s is computed as the sum of the average monthly market-adjusted returns.
4
In 2004, the Small and Medium Enterprises Board (SME Board) was launched in the Shenzhen Stock Exchange as a segment within
the main board. It aims to provide a direct financing platform for small and medium enterprises. The SME board serves as an important
exit channel for VC companies.
Table 2
Summary statistics of variables.
Panel A. Correlation matrix between selected variables
VC Proceeds Flotation Firm Offer PE CEO age Underwriter Auditor Pre IPO
cost age price ratio reputation reputation market
VC 1.000 0.088 0.098 0.034 0.064 0.025 0.055 −0.025 −0.149⁎ −0.195⁎⁎
Proceeds 1.000 0.863⁎⁎ 0.085 0.279⁎⁎ 0.130 0.002 0.012 −0.209⁎ 0.031
Flotation cost 1.000 0.142⁎ 0.201⁎⁎ 0.250⁎⁎ 0.013 0.146⁎ −0.153⁎ 0.025
Firm age 1.000 0.110 0.041 0.195⁎⁎ −0.005 −0.135⁎ −0.026
Offer price 1.000 0.156⁎ −0.135⁎ 0.087 −0.063 −0.010
PE ratio 1.000 −0.041 0.140⁎ 0.012 0.136⁎
CEO age 1.000 −0.044 0.036 0.013
Underwriter reputation 1.000 −0.116 0.021
Auditor Reputation 1.000 0.017
Pre IPO market 1.000
Panel B: Descriptive statistics: VC and non-VC-backed IPOs at the time of the IPO.
VC-backed Non-VC-backed Difference (VC-non VC-backed)
Mean Median Mean Median t-Statistic z-Statistic
Firm age (years) 5.14 4 4.92 5 (0.51) (0.20)

Offer price 11.11 10 10.33 9.77 (1.22) (1.13)
Offer size (RMB10,000) 92,629.15 27,855 85,394.73 24,816 (0.34) (1.95)⁎⁎
Flotation cost (RMB10,000) 3236.95 1879.77 2543.22 1662.94 (2.54)⁎⁎ (3.26)⁎⁎⁎
Percentage floatation cost 6.31 5.80 6.69 6.40 (−0.88) (−0.70)
P/E ratio 25.86 27.91 25.63 26.99 (0.29) (0.49)
Total asset (RMB10,000) 6,548,600 37,821 5,049,700 35,208 (1.4) (0.74)
Total debt (RMB10,000) 6,370,300 20,306 4,794,700 19,595 (1.38) (1.34)
Debt ratio 0.55 0.56 0.54 0.56 (0.26) (0.44)
Profit growth ratio 1.48 1.23 1.45 1.2 (0.18) (0.44)
ROA 0.12 0.1 0.11 0.1 (1.06) (0.79)
⁎ Indicates significance at the 10% level.
⁎⁎ Indicates significance at the 5% level.
⁎⁎⁎ Indicates significance at the 1% level.
BHARi is the difference between the holding period return of company i and the market return and is
estimated as:
"
T T
BHARiT ¼ ∏ ½1 þ r it − ∏ ½1 þ r mt ð1Þ
t¼1 t¼1
The mean BHAR over period T is:
1X n
BHART ¼ BHARiT ð2Þ
n i¼1
4. Results
4.1. Univariate results: underpricing
We begin the analysis by presenting evidence on the level of underpricing of both VC-backed and non-VC-
backed firms. During our study period, there were 149 VC companies conducting 261 investments in those
120 IPO firms. On average, an IPO firm receives funding 2.18 times from VC companies. This is higher than
that documented for Singapore (1.63 times) by Wang et al. (2003) but lower than that documented for the
US (2.92 times) by Barry et al. (1990). The descriptive statistics of the VC-backed and non-VC-backed compa-
nies are shown in Table 3 Panel A, and the level of underpricing is presented in panel B. The mean VC invest-
ment duration, defined as the number of years between the IPO date and the date of the VC's first investment
Table 3
Underpricing and VC involvement in IPOs.
Panel A: VC involvement in Chinese IPOs
Mean Median Standard deviation
VC investment duration (year) 2.70 2.90 2.97

VC equity holding before IPO (%) 20.34 11.70 21.99
VC equity holding after IPO (%) 15.79 9.36 17.43
Panel B: Underpricing of IPOs
VC-backed Non-VC-backed Difference
Initial Market-adj. Initial Market-adj. Initial t-/z-Stat Market adj. t-/z-Stat
(a) (b) (c) (d) (a)–(c) (b) – (d)
Mean 148.27 150.68 181.33 135.27 −33.06 (−0.78) 15.41 (1.19)

Median 115.72 128.39 115.72 113.78 0 (0.48) 14.61 (1.22)
Max 472.52 562.51 4900 567.64 −4427 −5.13
Min 5.13 4.24 13.67 17.58 −8.54 −13.34
N 114 114
This table presents statistics on underpricing and VC involvement in the investee firms. Panel A provides descriptive statistics of VC invest-
ment in the firms while panel B presents results of univariate test of differences in means and median underpricing.
in the company is 2.70 years. The duration is longer than that documented for Singapore VC-backed compa-
nies of 2 years by Wang et al. (2003), but is comparable to the 2.92 years documented for the US by Barry et al.
(1990). The average VC equity stake of 20.34% before the IPO and 15.79% after the IPO demonstrates fairly high
institutional holdings. With such a large stake, VCs would be expected to closely monitor their investee firms
subsequent to the IPO and at the same time send credible signals about their beliefs in the firms' prospectus.
We observe from Table 3 that both VC-backed IPOs and non-VC-backed IPOs are underpriced. Though the
magnitude of the mean initial returns for the VC-backed sample is lower than that of the non VC-backed firms,
the difference is not statistically significant. The finding that the presence of VC does not lead to lower
underpricing stands in contrast to the results documented by Megginson and Weiss (1991) for the US
but are similar to those documented by Wang et al. (2003) for Singapore and Da Silva et al. (2003) for
Australia. VCs also maintain significant holding in the investee firms after the IPO.5
4.2. Univariate results: stock market performance
To assess the differences in market performance between the VC-backed and non-VC-backed IPOs, we
examine the three-, six- and nine-months returns as well as the one-, two- and three-year buy-and-hold ab-
normal returns (BHAR) and cumulative abnormal returns (CAR) for the sample firms. The results are shown in
Table 4. In general, firms with and without VC backing underperform in the long run; however, the VC-backed
firms perform better as reflected in the magnitude of the excess returns and the difference in mean test. The
long-run underperformance of the VC-backed group is statistically significant at 1% for only the three- and
six-month returns but is not statistically significant in other time periods. The underperformance of non-
VC-backed group is much more severe and is statistically significant at 1% for the three-, six-, nine-, twelve-,
and fifteen-month windows. The difference in performance over these periods, which ranges from 5% to
18%, are statistically significant. Judging from the magnitude of the difference in the returns, the value of VCs'
involvement in the investee firm appears to increase over time, as the after-market stock return differential be-
tween the two groups of 5% for the three-month window rises to approximately 15% and 20% for the six-month
and one-year window, respectively. The finding of better long-run stock performance is consistent with the
monitoring role of the VC. While our results are consistent with those of Brav and Gompers (1997) and
Campbell and Frye (2006) who find that VC-backed IPOs perform better, for our sample the effect of VC
5
It should be noted that IPOs are but one exit vehicle that VCs use to harvest their investments. Other types of private exits include
acquisitions, secondary sales and buybacks. It is worth mentioning however that in our study, the IPOs cannot be viewed as an immediate
exist strategy for the VC firms as VCs maintain substantial holding in their portfolio companies after the IPO.
Table 4
Long-run stock market performance of VC- and non-VC-backed IPOs.
Buy-and-hold returns (BHAR) Cumulative Abnormal Returns (CAR)
Period VC-backed Non-VC-backed Difference VC-backed Non-VC-backed Difference
3_mth −0.0628 −0.1136 0.0508 −0.0511 −0.0976 0.0464

(−2.852)⁎⁎⁎ (−5.241)⁎⁎⁎ (1.660)⁎ (−2.482)⁎⁎ (−4.760)⁎⁎⁎ (1.689)⁎
6_mth −0.0852 −0.2285 0.1433 −0.0392 −0.1684 0.1292
(−2.923)⁎⁎⁎ (−6.569)⁎⁎⁎ (3.224)⁎⁎⁎ (−1.489) (−6.224)⁎⁎⁎ (3.492)⁎⁎⁎
9_mth −0.0880 −0.2252 0.1372 −0.0383 −0.1404 0.1021
(−1.805)⁎ (−4.185)⁎⁎⁎ (1.918)⁎ (−1.034) (−3.873)⁎⁎⁎ (1.984)⁎
12_mth −0.0817 −0.2742 0.1925 −0.0168 −0.1451 0.1284
(−1.238) (−4.599)⁎⁎⁎ (2.251)⁎⁎ (−0.404) (−3.519)⁎⁎⁎ (2.334)⁎⁎
15_mth −0.0921 −0.2067 0.1146 −0.0039 −0.1156 0.1117
(−1.496) (−2.895)⁎⁎⁎ (1.260) (−0.092) (−2.558)⁎⁎ (1.931)⁎
18_mth −0.0583 −0.0942 0.0359 0.0225 −0.0290 0.0515
(−0.918) (−1.291) (0.381) (0.509) (−0.582) (0.816)
21_mth −0.0211 −0.0416 0.0205 0.0248 −0.0006 0.0254
(−0.312) (−0.612) (0.227) (0.528) (−0.011) (0.383)
24_mth 0.0149 −0.0218 0.0367 0.0719 0.0136 0.0583
(0.201) (−0.257) (0.340) (1.476) (0.243) (0.842)
36_mth 0.0564 0.1304 −0.0740 0.1762 0.1379 0.0383
(0.360) (0.291) (−0.349) (2.699)⁎⁎⁎ (1.658)⁎ (0.460)
This table presents after market mean abnormal returns of the VC backed and non VC-backed IPOs for the three years following the IPO.
The cumulative abnormal returns (CAR) are the market adjusted abnormal returns.
involvement in the firm disappears after the first year of the IPO. Beyond this period, the difference between the
two groups is not significant at conventional levels. Overall, our univariate results support the monitoring role
of venture capitalists.
4.3. Cross-sectional regression analysis
The aggregate (univariate) results presented in Table 3 can conceal the effects of VC participation in the
IPO as they are only suggestive. They do not allow for the control of issuer characteristics. Megginson and
Weiss (1991), among others, find that VC-backed firms have relatively better post-IPO performance.
Therefore, to examine the effects of VC participation in the IPO on the firm's performance while controlling
for issuer and firm characteristics, we estimate the following model:
Performance ¼ α þ β1VCDummy þ β2Log ðFlotationCostsÞ þ β3Log ðProceedsÞ þ þβ4Firm Age

þ β5OfferPrice þ β6Price=Earningratio þ β7Log ðCEO AgeÞ þ β8SharesRetained
þ β9UnderwriterRep þ β10AuditortRep þ β11PreIPOMarketReturn
þ β12MainBoardDummy þ β13 ShanghaiExchangeDummy
2008
þ β14 High−TechnologyDummy þ β15 ∑t¼1990 Year t þ ε1 ð3Þ
where Performance is either underpricing or the three-year market adjusted returns. We capture the effect of
venture capitalists' participation using a dummy variable (VC Dummy) that takes a value of 1 for VC-backed
IPOs and 0 otherwise. The natural logarithm of Flotation costs is used to examine the role of the certification pro-
vided by VCs (Megginson and Weiss, 1991). These authors find that the presence of a venture capitalist in the
issuing firm serves to lower the cost of going public. Firm Age and Offering Size are included as control variables
because they are firm attributes that affect IPO performance (Mikkelson et al., 1997 and Baker and Gompers,
2003). Firm Age is defined as the difference in years between the year of the IPO and the date of incorporation.
Young companies are relatively riskier, and therefore their issues would be expected to be more underpriced be-
cause of the risks surrounding the issue. Alternatively, a more established firm could wield more power in nego-
tiations with the underwriter and may be able to better influence the determination of the issue price. Offering
Size, defined as the natural logarithm of gross proceeds from the issue (in US$ million), is used to measure the
level of excitement that the issue creates. As Carter et al. (1998) argue, larger offerings are typically executed
by more established firms, thus risk and information asymmetry associated with the issue could be less. On
the other hand, a larger issue could generate more excitement in the market compared to a smaller issue, and
a higher level of excitement can lead to a higher level of underpricing. Following Jain and Kini (1995), we include
the log of Proceeds as a measure of offer size.
Shares retained, defined as the percentage of shares retained by existing shareholders, is used as a proxy for
signaling to capture the effect of the ‘insider stake hypothesis’, which posits that issuers have more incentives to
reduce underpricing when they are selling a larger portion of the firm (Allen and Faulhaber, 1989). Thus a high
level of retention suggests that the owners are confident about the future prospects of the firm. High ownership
retention will send a positive signal to the market and increase the demand for the issue, thus resulting in a
higher level of underpricing. Consistent with Jain and Kini (1995), we include Shares retained as an independent
variable in the regression to capture the effect of ‘insider stake hypothesis’. Fernando et al. (2004) find a signif-
icant relationship between Offer price and underpricing; therefore, we include offer price as a control variable.
Jain and Kini (1994) also find that IPO firms start out with expectations of high earnings growth in the future
relative to their industry counterparts. We include Price-earnings ratio as a proxy for growth opportunities.
Consistent with Jain and Kini (1994), we use the offer price to estimate the ratio. Since the age of a firm's
chief executive officer influences the timing of IPO (Yang et al., 2011) and consequently its initial returns, we
include CEO age as a control variable. We also examine the certification effect of intermediaries, namely under-
writers' and auditors' quality on the underpricing level. If a prestigious intermediary utilizes its reputation capital
to certify the value of an IPO, then it should have an inverse relation with initial return (Ritter, 1991). To measure
the underwriter/auditor quality, we used the number of offerings that have been underwritten by an
underwriter/auditor. Finally, previous studies including Ritter (1991) have found that market sentiments influ-
ence underpricing; therefore, we include market returns one month before an IPO as another explanatory vari-
able. Dummy variables are employed to capture differences in listing location and industry (high-tech) effects.
A set of time dummy variables (∑2008 t=1990Yeart) is included to capture any unobserved time effects not included
in the regressions.6
4.4. Results
4.4.1. Cross sectional analysis of underpricing

The results using the initial returns as the dependent variable are reported in Table 5. Specification 1 focus-
es on unadjusted initial returns, whereas model 2 uses the market-adjusted initial returns as the dependent
variable. We find that our variable of interest, VC dummy is positive and significant in both specifications,
suggesting that VC-backed IPOs are significantly more underpriced than non-VC-backed IPOs. The size of
the coefficient indicates that the level of underpricing for VC-backed IPOs is at least 29.2% more than that of
the non-VC-backed IPOs. This finding is contrary to that documented by Megginson and Weiss (1991),
Barry et al. (1990), and Gompers (1996) for the US and Johan (2010) for Canada who find that VC-backed
IPOs are less underpriced than non-VC-backed IPOs. However, our results are consistent with more recent
studies including Francis and Hasan (2001), Lee and Wahal (2004) among others for the US, Hamao et al.
(2000) and Arikawa and Imadeddine (2010) for Japan, Da Silva et al. (2003) for Australia, and Tykvova and
Walz (2007) and Elston and Yang (2010) for Germany who find that VC-backed IPOs realize higher initial ex-
cess returns than non-VC-backed IPOs. The PE ratio positively influences the level of underpricing, suggesting
that firms that have higher growth opportunities are more underpriced. On average, the level of underpricing
of high growth firms increases by 2.3%–2.9% (Models 1–4) and this effect is significant at the 5% level. This var-
iable may be capturing the effect of size; as small firms have higher growth opportunities. Market sentiment
in the months leading to the IPO is the most influential factor in explaining the level of initial underpricing.
The coefficient suggests that higher pre-IPO market returns generate higher levels of underpricing.
4.4.1.1. Sample selection bias and endogeneity. The decision by a firm to raise venture capital and the decision by
a VC to provide finance are not exogenous. Firm characteristics in particular may be important determinants
6
We thank an anonymous referee for suggesting the inclusion of year effects in the regression.
Table 5
Cross-sectional regression results of underpricing of Chinese IPOs.
Model 1 Model 2 Model 3 Model 4
Variable Unadjusted initial Adjusted initial Unadjusted initial Adjusted initial

return return return return
VC dummy 0.292 0.303

(2.590)⁎⁎ (2.621)⁎⁎⁎
VC transformed 0.598 0.601
(1.845)⁎ (1.829)⁎
Log (flotation costs) −0.562 −0.501 −0.501 −0.438
(−1.89)⁎ (−1.788)⁎ (−1.821)⁎ (−1.549)
Log (proceeds) 0.026 0.0002 −0.020 −0.047
(0.135) (0001) (−0.102) (−0.235)
Firm age −0.012 −0.006 −0.011 −0.004
(−0.724) (−0.337) (−0.620) (−0.238)
Offer price −0.016 −0.017 −0.016 −0.017
(−1.193) (−1.238) (−1.179) (−1.222)
PE ratio 0.023 0.028 0.024 0.029
(2.022)⁎⁎ (2.306)⁎⁎ (2.018)⁎⁎ (2.376)⁎⁎
Log (CEO age) 0.195 0.145 0.189 0.139
(1.370) (0.990) (1.306) (0.937)
Shares retained 0.023 0.258 0.842 0.577
(0.019) (0.204) (0.643) (0.429)
UnderwriterRep −0.001 −0.003 −0.003 −0.005
(−0.104) (−0.365) (−0.430) (−0.690)
AuditorRep −1.189 −1.473 −1.311 −1.602
(−1.304) (−1.453) (−1.319) (−1.570)
Pre IPO market return 2.017 1.464 1.840 1.283
(4.433)⁎⁎⁎ (3.135)⁎⁎⁎ (3.975)⁎⁎⁎ (2.698)⁎⁎⁎
Main board dummy 0.100 −0.176 0.232 −0.040
(0.154) (−0.265) (0.355) (−0.060)
Shanghai exchange dummy 0.027 0.265 0.062 0.301
(0.051) (0.490) (0.116) (0.550)
High-technology dummy 0.216 0.217 0.224 0.226
(1.567) (1.538) (1.618) (1.589)
Constant 2.989 3.590 1.963 0.376
(2.045)⁎⁎ (2.393)⁎⁎ (1.243) (0.270)
Year effect Yes Yes Yes Yes
Observations 225 225 225 225
Adjusted R-squared 0.560 0.407 0.401 0.396
F-statistic (9.29)⁎⁎⁎ (6.686)⁎⁎⁎ (9.021)⁎⁎⁎ (6.445)⁎⁎⁎
Selection model (probit) Coefficient Significance
Constant −3.381 0.006

Total assets 0.180 0.002
Debt ratio −0.655 0.133
Pre-offering ROA 1.383 0.163
This table presents the result of the cross-sectional regression of the initial returns of venture-backed and non-venture-backed IPOs.
Underpricing is computed as the difference between the closing price on the first trading day and offering price divided by the offering
price. VC dummy takes the value 1 if venture capitalists are involved in the IPO and 0 otherwise. VC Transformed is the predicted prob-
abilities from the probit regression. Log (Proceeds) is the natural logarithm of proceeds from an IPO. Firm Age is the number of years be-
tween the firm's incorporation and listing date. Offer price is the offering price. The PE ratio is the offer price divided by the earnings per
share. Log (CEO Age) is the natural logarithm of the age of a CEO. Shares Retained represents the percentage of shares retained by insiders
in the firm. UnderwriterRep is the number of offerings an underwriter has underwritten. AuditorRep is the number of offerings an auditor
has performed audit. Pre-IPO Market Return is defined as the market return one month before a new offering. Main Board Dummy is a
dummy that takes the value 1 if the firm is listed on the main board and 0 otherwise. Shanghai Exchange Dummy is a dummy that
takes the value 1 if a new firm is listed on the Shanghai Stock and 0 otherwise Exchange. High-Technology Dummy is a variable that
takes the value 1 if the firm belongs to a high-technology industry and 0 otherwise. Log (Assets) is the natural logarithm of total assets.
Debt ratio is the debt divided by total assets. Pre-Offering ROA is the pre-listing return on assets. The t-statistics are based on White's
(1980) heteroscedasticity-consistent method.
when a VC decides whether or not to back a firm. Moreover, the matching process used raises concerns re-
garding sample selection bias. In order to address this issue, we compare results of a two stage regression
with results of our previous regression models. Specifically, the Heckman (1979) method is used whereby
VC dummy is first explained by firm characteristics including total assets (size), debt ratio (leverage) and
pre offering return on assets (profitability) using probit regression. Then, predicted probabilities from the
probit regressions are transformed into inverse Mill ratios. The ratios are then used to predict IPO returns.
Specifications 3 and 4 of Table 5 show results from the two stage regression. As observed, when compared
with specifications 1 and 2, there is no significant difference in both the sign and magnitudes of the coeffi-
cients, suggesting that our results concerning the effects of venture capitalists are robust after controlling
for endogenous choice of venture capital funding.
4.4.2. Cross sectional analysis of long run stock market returns

Results of regressions using the long-run stock market returns as dependent variables are presented in
Table 6. In the first three specifications, the coefficient of our variable of interest, the VC dummy, shows
that VC-backed IPOs perform better than non-VC-backed firms. The three models indicate that VC-backed
Table 6
Cross-sectional regression results of long-term performance of Chinese IPOs.
Model 1 Model 2 Model 3 Model 4 Model 5
Variable M3 MCAR M6 MCAR MCAR1 MCAR2 MCAR3
VC dummy 0.030 0.081 0.079 −0.121 −0.219

(1.835)⁎ (3.250)⁎⁎⁎ (2.010)⁎⁎ (−1.371) (−1.166)
Log (flotation costs) 0.055 −0.049 −0.128 −0.167 0.070
(1.556) (−1.076) (−1.341) (−1.349) (0.285)
Log (proceeds) −0.026 0.037 0.040 −0.021 −0.253
(−1.066) (1.177) (0.606) (−0.241) (−1.497)
Firm age −0.003 0.002 0.004 0.001 −0.004
(−1.404) (0.735) (0.663) (0.139) (−0.284)
Offer price 0.006 0.008 0.010 0.016 0.033
(2.296)⁎⁎ (2.478)⁎⁎ (2.129)⁎⁎ (2.657)⁎⁎ (2.524)⁎⁎
PE ratio −0.001 −0.010 −0.002 0.003 −0.030
(−0.519) (−2.190)⁎⁎ (−0.513) (0.506) (−0.844)
Log (CEO age) −0.059 −0.049 −0.045 −0.158 −0.527
(−1.816)⁎⁎ (−1.870)⁎ (−0.923) (−2.18)⁎⁎ (−3.198)⁎⁎⁎
Shares retained 0.240 −0.102 −0.695 −0.644 1.527
(1.529) (−0.498) (−1.631) (−1.160) (1.397)
UnderwriterRep 0.001 0.005 0.012 0.006 −0.011
(1.198) (3.732)⁎⁎⁎ (3.565)⁎⁎⁎ (1.651) (−1.563)
AuditorRep −0.141 −0.433 −0.220 0.119 −3.216
(−1.127) (−1.635) (−0.646) (0.267) (−1.681)
Underpricing −0.058 −0.013 0.006 −0.094 −0.123
(−3.716)⁎⁎⁎ (−1.129) (0.245) (−1.082) (−1.052)
Main board dummy −0.012 0.150 −0.468 −0.574 −0.086
(−0.149) (1.395) (−2.093)⁎⁎ (−1.973)⁎⁎ (−0.149)
Shanghai exchange dummy 0.092 0.135 0.993 1.309 0.766
(1.369) (1.533) (2.445)⁎⁎ (2.518)⁎⁎ (1.640)
High-technology dummy −0.064 −0.054 0.107 0.145 0.194
(−3.649)⁎⁎⁎ (−2.364)⁎⁎ (2.259)⁎⁎ (2.346)⁎⁎ (1.590)
Constant 0.205 0.017 1.427 2.900 3.162
(1.096) (0.071) (2.807)⁎⁎⁎ (4.385)⁎⁎⁎ (2.428)⁎⁎
Year effect Yes Yes Yes Yes Yes
Observations 225 225 225 225 225
Adjusted R-squared 0.236 0.409 0.332 0.275 0.120
F-statistics (3.563)⁎⁎⁎ (6.748)⁎⁎⁎ (5.118)⁎⁎⁎ (4.147)⁎⁎⁎ (2.136)⁎⁎⁎
This table presents the results of the cross-sectional regression of the after-market returns accruing to investors who bought shares of
venture backed and non-venture backed IPOs on the first trading day and held for 3, 6, 12, 24 and 36 months. T-statistics are based on
White's (1980) heteroscedasticity-consistent method.
IPOs perform better by 3% to 8% than their counterparts. However, consistent with the univariate results
presented in Table 4, we find that beyond the first year the effect of VC involvement in the investee firm
disappears. This result is consistent with that of Johan (2010) who finds that VC backing helps the investee
firms performance only in the first year. Similar to previous IPO studies, we also observe that underpricing
is negatively related to the post-IPO stock market performance, but only in the first three months following
the IPO. Model 1 shows that when the underpricing level goes up by 1%, the after-market stock performance
drops by 6% and this effect is significant at the 1% level. The offer price is consistently positive and significant
suggesting that higher offer price conveys information about the long run performance of the firm. Firms with
higher issue price perform better by 0.60% to 3.3%. Higher issue price may be offered by more established
firms with a track record that perform well in the post-IPO period. Firms with younger CEOs also perform
better, the coefficient of CEO age in Models 1–5 indicate that IPOs managed by older CEOs underperform by
5%–53% from 3 months to 3 years after the IPO. We also find that although underwriter reputation
does not influence initial returns, it affects the after-market returns positively. The average six- and twelve-
months after-market returns are higher for IPOs managed by more reputable underwriters but such effect
vanishes after the first year of the IPO. During the two said periods, the post-IPO market performance of
reputable underwriter is better by 0.5% to 1.2% respectively and the effect is significant at the 1% level. The
high-tech firms underperform in the first six months following the IPO but beyond that period we observe
that high-tech firms perform better than non-high-tech IPOs.
4.4.3. Robustness test: reverse causality between VC's and underwriter's reputation with firm performance
We are concerned about the possible existence of reverse causality between VC's involvement in the firm,
underwriter's reputation and firm performance and the attendant simultaneity bias. If common industry fac-
tors affect the sample firms, then the disturbance terms of these equations are likely to be contemporaneously
correlated. Ignoring this contemporaneous correlation and estimating these equations separately leads to
inefficient estimates of the coefficients. Moreover, the existence of reverse causality among variables such
as underwriter's and auditor's reputation and VC's involvement suggests that the regression models can
contain variables that appear on the left-hand side in one equation and on the right-hand side of another
equation. Ignoring the endogeneity of these variables can lead to inconsistent estimates. This simultaneity
bias can be corrected by applying a “two-stage least squares” (2SLS) estimation. Combining this estimation
method with the SUR method results in a simultaneous estimation of the system of equations as per the
“three-stage least squares” (3SLS) method which generates consistent estimates (Zellner and Theil, 1962).
Using the 3SLS-GMM estimation procedure as proposed by Schmidt (1990) (which is consistent and asymp-
totically efficient when disturbance terms are contemporaneously correlated) to examine the existence of
reverse causality using a system of simultaneous equations involving the four potential sources of reverse
causality (underpricing, VC or not VC, underwriters' reputation and auditors' reputation) and the other
controlling variables as instruments, we obtained the following system of four equations:
Underpricing ¼ −2:33 þ 2:29 VC þ0:10 Underwriter Reputation þ 11:86 Auditor Reputation
VC ¼ 0:73 þ0:09 Underpricing −0:02 Underwriter Reputation þ1:48 Auditor Reputation
Underwriter Reputation ¼ 19:39 þ3:98 Underpricing −19:24 VC þ0:20 Auditor Reputation
Auditor Reputation ¼ −0:01 þ 0:02 Underpricing þ 0:08 VC −0:00002 Underwriter Reputation
As the results indicate, the relationship between underpricing and VC does not change when the major
sources of reverse causality are jointly considered.
5. Further analysis of the performance of VC-backed IPOs in China
In this section, we provide further analysis of the performance of VC-backed IPOs in China with the view to
generating further insights into the value-added function of the VC in the investee firms. We test whether VC
and CEO characteristics and their interactions affect the underpricing and after-market performance of the
investee firms. Specifically, we examine whether VC prestige power (reputation), VC ownership or controlling
power and VC structural power affect the investee firms' underpricing and post-issue performance as argued
by Chahine and Goergen (2010). The VC's ability to influence the investee firm may also depend substantially
on the CEO of the funded firm. Therefore, we examine VC's characteristics in conjunction with CEO character-
istics, such as CEO ownership or controlling power, CEO education and CEO duality and their interaction
thereof on the performance of the investee firms by estimating the following model:
X
D X
F X
H
Performancei; j ¼ α 0 þ α n VC Chari; j þ α n CEO Char i; j þ VC α n CEO Chari; j ð4Þ
n¼1 n¼Dþ1 n¼ Fþ1
X
K
þ α n Firm Char i; j þ ui; j
n¼Hþ1
Specifically, we estimate the following regression:
IPO Performance ¼ α þ β1ΔVC Holding þ β2VC Syndicate

¼ α þ β1ΔVC Holding þ β2VC Syndicate þ β3VC Controlling Power
þ β4VC Reputation þ β5VC Structural power þ β6 VC duration
þ β7CEO Education þ β8CEO Controlling Power þ β9CEO Duality
þ β10CEO Participation þ β11PreIPOMarket Return þ β12FirmAge þ β13Growth
þ β14Debt Ratio þ β15LogðProceedsÞ þ β16Price=Earnings ratio
2008
þ β17UnderwriterRep þ β18AuditortRep þ β15∑t¼1990 Year t þ ε 1 ð5Þ
where IPO Performance is underpricing or aftermarket stock market performance, ΔVC Holding is the percent-
age of VC's holdings sold during the IPO, and VC Syndicate is the number of VCs in the investee firm. VC
Controlling power is the VC share ownership prior to the IPO. VC Prestige power is the number of IPOs a VC
has previously been involved with. VC's structural power is a dummy variable equal to 1 if the VC is a top 10
shareholder and 0 otherwise; and VC duration is the number of years from the time of the VC's investment
to the IPO date. CEO ownership power is the percentage of shares owned by the CEO prior to the IPO; CEO
education is a dummy variable if the CEO has a PhD or Master's degree and zero otherwise; CEO participation
is the CEO's shares sold as a percentage of the shares outstanding at the time of the IPO; CEO Duality is a
dummy variable that takes the value of 1 if the CEO is also the chairperson of the firm and 0 otherwise.
Firm Age is the number of years since incorporation; Growth is the growth in net income, DR is the debt
ratio at the time of the IPO, and Price/Earnings ratio is the offer price divided by earnings per share, and is a
proxy for growth opportunities, a variable that prior research (including Mikkelson et al., 1997; Carter
et al., 1998; Baker and Gompers, 2003) has suggested can affect underpricing.
VCs' desire to protect their reputational capital can affect the magnitude of underpricing of the investee
firm. In line with Chahine and Goergen (2010), we measure VC reputation as the number of IPOs in which
the VC has previously been involved. As Sorenson and Stuart (2001) argue, a VC may acquire prestige
power from its past successful experience in the capital market, which can affect performance. Where a
firm had syndicate VCs, we focus on the reputation of the lead VC. Following Hochberg et al. (2007), we define
lead VC as the one with the largest investment in the firm at the time of the IPO. Krishnan et al. (2011) show
that lead VCs are more likely to hold board seat and shares at and beyond the IPO date and that their guidance,
support and more importantly, their experience and reputation are likely to affect the short-term and long-
term performance of the investee firms.
VC controlling (or ownership) power, which we measure as the percentage of the firm's shares owned by
the VC prior to the IPO, is suggestive of the VC's ability to influence the decision making in the firm. Ideally, VC
structural power should reflect the position of the VC in a syndicate and how the VC can influence decision
making in the syndicate and the firm. Due to lack of data, we consider the position of the VC in the top 10
shareholders as a measure of the VC structural power. Our measure of VC structural power is a dummy
equal to 1 if the VC is a top-10 shareholder and 0 otherwise. In addition, we measure VC participation in
the issue (ΔVC holding) as the percentage of the VC's holdings sold during the IPO. The percentage of holdings
sold during the IPO may affect the pricing of the issue, as the VC would not like to leave too much money on
the table. Habib and Ljungqvist (2001) find that VCs who sell a higher proportion of their equity in the firm
have greater incentives to take actions to reduce underpricing. Therefore, we expect that a significant change
in VC holding will lead to less underpricing.
We also examine the impact of VC syndication on performance, as prior studies (including Hochberg et al.,
2007) show that VC syndication has a positive impact on firms' performance because the syndicate creates a
network that facilitates the sharing of resources, information, and contact, of which the latter is very impor-
tant in China. In addition, it is reasonable to surmise that a syndicate of VCs will be able to push for board rep-
resentation for their members than VCs that act as the sole provider of venture capital in the investee firm,
especially those that may have difficulty in dealing with powerful CEOs (Chahine and Goergen, 2010). How-
ever, it is also reasonable to expect VC syndication to have negative effects on the performance of the investee
firm, as the syndicate may find it difficult to make decisions in a decisive and efficient manner. We also include
VC duration (defined as the number of years from the date of the investment to the IPO date) to examine the
grandstanding hypothesis. If the grandstanding hypothesis holds in China, we would expect VC duration to be
negatively related to underpricing, as VCs that have not been affiliated with the firm for a long time but want
to take it public early would underprice the issue significantly.
Prior studies also suggest that a VC's involvement in the investee firm and their ability to monitor and add
value will depend on the CEO's controlling power (Hermalin and Weisback, 1988). We measure the CEO's
controlling power as the fraction of the shares outstanding owned by the CEO. We examine the effects of
CEO Education (which can proxy for managerial influence) and its interaction with VC characteristics on
the performance of the investee firms. VCs may be less likely to take actions that enhance their own interest
if the CEO is highly educated or is powerful. Hermalin and Weisback (1988) show that VCs are less likely to sit
on the boards of, or become involved with, firms that have powerful managers, those CEOs who have substan-
tial holdings in the firm, highly educated CEOs, and CEOs who are also the chairperson of the board (CEO
duality). Consistent with prior studies (Rechner and Dalton, 1991), we include CEO duality a measure of man-
agerial discretion which can affect performance. CEO age is included as a proxy for experience (Baker and
Mueller, 2002). We examine the impact of these CEO characteristics on underpricing and long-run stock
market performance of VC-backed firms. Time dummy variables (∑2008 t = 1990Yeart) are included to capture
any unobserved time effects not captured in the regressions.
5.1. Results: impact of VC and other governance characteristics on the underpricing of VC-backed IPOs
Consistent with prior studies, including Chahine and Goergen (2010), we conjecture that IPO pricing is the
result of the balance of power within the investee firm, specifically between the VC and the CEO. It is possible
that powerful VCs would use their skills and power in the pricing process to reduce underpricing. We conjec-
ture that higher VC and CEO holdings prior to the IPO would lead to lower underpricing. VCs' desire to protect
their reputational capital can affect the magnitude of underpricing of the investee firm. Lerner (1994) also
finds that more experienced venture capitalists are more proficient in the timing of the IPO, thus reducing
the level of underpricing. Similarly, a VC's controlling power (pre-IPO holdings) can affect the underpricing
of its investee firm. According to the signaling model of Grinblatt and Hwang (1989), the percentage of insider
holding signals to the market the amount and quality of private information possessed by the insiders.
The results of the regression of initial returns of the VC-backed sample on VC and other governance char-
acteristics are presented in Table 7. Focusing on VC characteristics, we observe that VC reputation significantly
affects the underpricing of the IPO. The negative coefficient suggests that reputable and presumably more
experienced VCs use their expertise and influence to reduce underpricing. VC syndication leads to higher
underpricing. The coefficient of VC controlling power is consistently negative and significant, suggesting
that the larger the VC holdings prior to the IPO, the lower underpricing. The coefficient of VC duration is
also positive and consistently significant, implying that high VC investment duration leads to higher
underpricing. The consistently positive and strongly significant coefficient of duration does not support the
grandstanding hypothesis, especially in light of the finding that VC investment duration in China is longer
than that documented in other countries. We introduce CEO characteristic in model 2 and observe that the
variable that proxy for CEO controlling power is negative and significant, suggesting that larger CEO pre-
IPO holdings lead to lower underpricing. While CEO duality does not affect the level of underpricing, we
find that underpricing of firms with CEO Duality and syndicate VCs is much lower. Firms with strong structural
power (top 10 VCs) and CEO duality are significantly underpriced. We also find that the coefficient of log
Table 7
Cross-sectional regression results of underpricing of VC-backed IPOs.
Variable Model 1 Model 2 Model 3 Model 4
Constant 1.60 1.912 6.153 5.658

(6.74)⁎⁎⁎ (5.78)⁎⁎⁎ (2.23)⁎⁎ (1.93)⁎
ΔVC Holding 0.006 0.009 0.006 0.004
(0.37) (1.03) (0.63) (0.40)
VC Syndicate 0.127 0.137 0.034 0.037
(3.50)⁎⁎⁎ (3.34)⁎⁎⁎ (0.67) (0.68)
VC Controlling power −0.014 −0.024 −0.022 −0.018
(−2.17)⁎⁎ (−4.46)⁎⁎⁎ (−3.89)⁎⁎⁎ (−1.93)⁎
VC Reputation −2.59 −3.039 4.93 4.074
(−1.87)⁎ (−1.67)⁎ (1.34) (1.04)
VC Structural power −0.030 −0.004 0.054 0.119
(−0.21) (−0.03) (0.37) (0.56)
VC Investment duration 0.080 0.110 0.092 0.094
(2.62)⁎⁎ (3.58)⁎⁎⁎ (2.71)⁎⁎⁎ (2.64)⁎⁎⁎
CEO Education −0.325 −0.297 −0.342
(−1.49) (−1.41) (−1.51)
CEO Controlling power −1.557 −2.37 −2.08
(−2.67)⁎⁎⁎ (−3.90)⁎⁎⁎ (−3.17)⁎⁎⁎
CEO Duality 0.109 0.192 0.741
(0.48) (0.82) (1.52)
CEO Participation −0.446 −0.40 −0.774
(−0.78) (−0.64) (−1.09)
Pre-IPO market return 2.58 2.073
(0.51) (0.42)
Firm age 0.010 0.010
(0.378) (0.32)
Growth rate 0.189 0.212
(1.91)⁎ (2.06)⁎⁎
Log(proceeds) −0.549 −0.537
(−2.17)⁎⁎ (−2.13)⁎⁎
PE ratio 0.031 0.034
(1.11) (1.08)
Auditor reputation 1.816 1.61
(1.03) (0.81)
Underwriter reputation 0.051 −0.26
(0.02) (−0.08)
CEO Duality ∗ VC Syndicate −1.15
(−2.52)⁎⁎
CEO Duality ∗ VC Controlling power −0.01
(−0.64)
CEO Duality ∗ VC Structural power 0.94
(2.17)⁎⁎
Year effect Yes Yes Yes Yes
Observations 114 114 114 114
Adjusted R-squared 0.11 0.20 0.243 0.235
F-statistic (2.07)⁎⁎ (2.46)⁎⁎⁎ (2.285)⁎⁎⁎ (2.097)⁎⁎⁎
This table presents the results of the regression of the initial returns of venture-backed IPOs. ΔVC holding is the percentage of VCs' hold-
ings sold during the IPO. VC Syndicate is the number of VCs in the investee firm. VC controlling power is the VC share ownership prior to
the IPO. VC reputation is defined as the number of IPOs the VC has previously been involved with. VC's structural power is a dummy that
takes the value of 1 if the VC is a top 10 shareholder and zero otherwise, and VC investment duration is the time from the year of VC in-
vestment to the IPO date. CEO education is a dummy that takes the value of 1 if the CEO has a PhD or Master's degree and 0 otherwise. CEO
controlling power is the percentage of the shares owned by the CEO prior to the IPO. CEO duality is a dummy that takes the value of 1 if the
CEO is the board chairperson and 0 otherwise. The rest of the variables are as defined before. The t-statistics are based on White
heteroscedasticity-consistent method.
proceeds (a proxy for size) is negative and significant, suggesting that smaller issues (with higher information
asymmetry) are associated with higher underpricing.
5.2. Further analysis: impact of VC and governance characteristics on long-term stock market performance of
VC-backed IPOs
Venture capitalists provide not only capital to the investee firm but also financial advice that can add value to
the portfolio firms. Therefore, their involvement in the firms can enhance the firm's after-market performance.
Table 8
Cross-sectional regression results of long-term performance of Chinese VC-backed IPOs.
Variable M3 MCAR M6 MCAR MCAR1 MCAR2 MCAR3
Constant 0.175 −0.806 −0.843 −2.557 −2.370

(0.38) (−1.09) (−0.56) (−1.21) (−0.95)
VC Syndicate 0.02 0.023 −0.029 −0.112 0.960
(1.20) (0.71) (−0.55) (−1.41) (1.75)⁎
VC Controlling power −0.001 −0.002 −0.004 −0.004 0.006
(−0.73) (−1.10) (−1.15) (−0.70) (0.96)
VC Reputation −1.66 −2.29 −1.01 −0.67 0.713
(−1.70)⁎ (−1.42) (−0.33) (−0.15) (0.16)
VC Structural power 0.052 0.067 0.104 0.066 −0.989
(1.29) (1.32) (1.21) (0.59) (−1.89)⁎
VC Investment duration −0.024 −0.023 −0.016 −0.040 0.078
(−2.03)⁎⁎ (−1.74)⁎ (0.75) (−1.71)⁎ (1.32)
CEO Education −0.013 −0.012 −0.261 −0.431 −0.114
(−0.15) (−0.11) (−1.37) (−1.76)⁎ (−0.29)
CEO Controlling power −0.179 0.22 0.571 1.238 1.587
(−1.31) (1.03) (2.11)⁎⁎ (3.15)⁎⁎⁎ (2.29)⁎⁎
CEO Duality 0.059 0.10 0.336 0.331 0.200
(0.52) (0.82) (1.63)⁎ (1.11) (0.36)
Underpricing −0.086 −0.057 −0.054 0.001 −0.081
(−2.80)⁎⁎⁎ (−1.86)⁎ (−1.02) (0.12) (−0.43)
Firm age 0.014 0.019 0.012 −0.001 0.056
(2.41)⁎⁎ (2.58)⁎⁎ (1.19) (−0.09) (0.90)
Growth rate 0.060 0.061 0.015 0.366 0.195
(1.97)⁎⁎ (1.88)⁎ (0.45) (2.98)⁎⁎⁎ (0.88)
Debt ratio 0.37 0.341 0.146 0.115 −1.057
(1.73)⁎ (1.47) (0.32) (0.18) (−1.09)
Auditor reputation −0.305 −0.254 −0.302 −0.392 −0.063
(−0.81) (−0.55) (−0.37) (−0.29) (−0.03)
Underwriter reputation −0.438 0.309 1.61 0.677 −2.960
(−0.64) (0.36) (1.33) (0.36) (−0.94)
Log(total asset) −0.028 0.037 0.056 0.095 0.110
(−1.13) (1.00) (0.67) (0.92) (0.84)
PE ratio 0.003 −0.008 −0.006 0.013 −0.012
(0.56) (−1.25) (−0.44) (0.73) (−0.44)
CEO Duality ∗ VC syndicate −0.058 −0.096 −0.165 −0.216 −0.329
(−1.14) (−1.53) (−1.64)⁎ (−1.47) (−1.49)
CEO Duality ∗ VC Controlling power 2.886 1.885 0.192 −1.472 0.612
(2.86)⁎⁎⁎ (1.19) (0.08) (−0.35) (0.13)
CEO Duality ∗ VC Structural power 0.002 0.020 0.185 0.326 0.070
(0.01) (0.34) (1.86)⁎ (2.71)⁎⁎⁎ (0.38)
Year effects Yes Yes Yes Yes Yes
Observations 101 101 101 101 101
Adjusted R-squared 0.213 0.326 0.189 0.059 0.052
F-statistic (1.97)⁎⁎ (2.79)⁎⁎⁎ (1.86)⁎⁎ (1.22) (1.10)
This table presents results of additional analysis of the after-market performance of the VC-backed firms. The dependent variable is
the aftermarket stock market performance of VC-backed IPOs. The short-term three- and six-month as well as the one-, two- and
three-year long-term stock market performance is examined. The explanatory variables are as defined before.
We have already shown that VC-backed IPOs perform better than non-VC-backed IPOs. In this section, we
explore the impact of VC characteristics on the stock market performance of VC-backed IPOs. To examine the
value-added effect of VC participation in the investee firms, we re-estimate Eq. (4) using the after-market
stock returns as the dependent variable. We replace VC and CEO share ownership prior to the IPO with VC
and CEO share ownership after the IPO as our measure of the VC's and CEO's controlling power respectively.
In addition, we also replace pre-IPO market returns (a proxy for market uncertainty) with underpricing. The re-
gression results are presented in Table 8.
We observe that among the VC characteristics that we include in the regression, VC investment duration
significantly affects the long term performance of the investee firms. A shorter duration of the VC investment
is associated with better performance, albeit the coefficient is significant in only the three- and six-months
and twenty-four-months CAR regressions. Growth rate is consistently positive albeit significant in three of
the five regressions, indicating that higher growth firms realize higher post-IPO stock returns. The stock
market performance of high growth firms improves by about 6%–36% two years after the IPO. Consistent
with the signaling hypothesis, the CEO controlling power (post-IPO shareholding) is significantly related to
firm performance. The coefficient is generally positive and significant, especially in the first, second, and
third years after the IPO. While CEO duality per se does not generally affect firm performance, the interaction
of CEO duality and VC structural power significantly affect performance. In other words, firms whose CEOs are
also the chairpersons of the board and have VCs who are among the top 10 shareholders perform better in the
long run. The influential VC is perhaps able to monitor the firm and/or offer advice that helps the firm to per-
form better. It is important to note that lack of data precluded the inclusion of other governance characteristics
such as VC board representation, a characteristic that may affect VC monitoring efforts. Nonetheless, these
regressions enable us to gain further insights into the value relevance of VC participation in the investee
firms in the post IPO period.
6. Conclusion
In this paper, we analyze the performance of VC-backed and non-VC-backed IPOs in China, a country
where venture capital investments and GDP have grown significantly in recent decades. We find, among
others, that VC-backed IPOs are larger in size, and have higher flotation cost. Second, both VC-backed and
non-VC-backed IPOs in China are underpriced in the immediate after market and underperform in the long
run. However, our cross sectional analysis indicates that VC-backed IPOs are more underpriced than non-
VC-backed firms. While this finding is contrary to that of Megginson and Weiss (1991), Barry et al. (1990)
and Gompers (1996) for the US, it is consistent with more recent studies that document higher underpricing
for VC-backed firms for different countries including Francis and Hasan (2001), Lee and Wahal (2004), among
others for the U.S., Hamao et al. (2000) and Arikawa and Imadeddine (2010) for Japan, Da Silva et al. (2003)
for Australia, and Tykvova and Walz (2007) and Elston and Yang (2010) for Germany. The finding that the
presence of VCs does not help to lower the IPO cost and/or reduce underpricing casts doubt on the certification
role of VCs in China. With regard to the long-run stock market performance, we find that both VC- and the
non-VC-backed firms underperform; however, the VC-backed firms perform significantly better than the
non-VC-backed firms. The finding supports the conjecture that VCs provide valuable post-issue monitoring
services that lead to better performance.
Although VC-backed firms in China are generally more underpriced than non-VC-backed firms, further
analysis of the impact of VC characteristics on the investee firms' performance indicates that firms with
reputable VCs are less underpriced. This suggests that highly reputable and presumably more experienced
VCs use their expertise and influence to reduce underpricing of the investee firm. Consistent with the insider
stake hypothesis, we also find that firms whose VCs and CEOs hold significant controlling power experience
lower underpricing. Whereas structural power of the VC does not affect underpricing, VC duration positively
influences underpricing, suggesting that the longer the VC's investment in the investee firm, the higher the
level of underpricing. This result, coupled with the finding that duration in China is longer than what has
been documented in other countries suggests that our Chinese IPO data does not support the grandstanding
hypothesis. We also test the value-enhancing effects of VCs' involvement on the investee firms' long-term
stock market performance and find that a shorter VC investment duration is associated with better long
term performance. CEO controlling power also positively affects firm performance, i.e., the higher the percent-
age of shares owned by the CEO, the better the firm's long run performance. Interestingly, we find that while
CEO duality per se does not impede performance, firms whose CEOs are also the chairpersons of the board
perform better if the firm has a VC who is a block holder (top 10 shareholder). These influential VCs are
perhaps able to offer advice and/or monitor the firm in a way that helps the firm to perform better.
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EMEMAR-00468; No of Pages 20

Emerging Markets Review xxx (2016) xxx–xxx

Contents lists available at ScienceDirect

Emerging Markets Review

Venture capitalist participation and the

Article history: We examine the effects of venture capitalist participation in IPOs in

2. Literature review and hypothesis development

3. Data and methodology

Panel A: Distribution of VC-backed IPO companies in China

Shenzhen Stock Exchange Shanghai Stock Exchange

Year Total Main Board SME Board Main Board

Panel B: Industry distribution of VC-backed and non-VC-backed IPOs

Industry Number of IPOs Percentage of IPOs

Panel A. Correlation matrix between selected variables

VC-backed Non-VC-backed Difference (VC-non VC-backed)

Mean Median Mean Median t-Statistic z-Statistic

Firm age (years) 5.14 4 4.92 5 (0.51) (0.20)

The mean BHAR over period T is:

4.1. Univariate results: underpricing

Panel A: VC involvement in Chinese IPOs

Mean Median Standard deviation

VC investment duration (year) 2.70 2.90 2.97

Panel B: Underpricing of IPOs

VC-backed Non-VC-backed Difference

Initial Market-adj. Initial Market-adj. Initial t-/z-Stat Market adj. t-/z-Stat

(a) (b) (c) (d) (a)–(c) (b) – (d)

Mean 148.27 150.68 181.33 135.27 −33.06 (−0.78) 15.41 (1.19)

4.2. Univariate results: stock market performance

Buy-and-hold returns (BHAR) Cumulative Abnormal Returns (CAR)

Period VC-backed Non-VC-backed Difference VC-backed Non-VC-backed Difference

3_mth −0.0628 −0.1136 0.0508 −0.0511 −0.0976 0.0464

4.3. Cross-sectional regression analysis

Performance ¼ α þ β1VCDummy þ β2Log ðFlotationCostsÞ þ β3Log ðProceedsÞ þ þβ4Firm Age

4.4.1. Cross sectional analysis of underpricing

Model 1 Model 2 Model 3 Model 4

Variable Unadjusted initial Adjusted initial Unadjusted initial Adjusted initial

VC dummy 0.292 0.303

Selection model (probit) Coefﬁcient Signiﬁcance

Constant −3.381 0.006

4.4.2. Cross sectional analysis of long run stock market returns

Model 1 Model 2 Model 3 Model 4 Model 5

Variable M3 MCAR M6 MCAR MCAR1 MCAR2 MCAR3

VC dummy 0.030 0.081 0.079 −0.121 −0.219

Underpricing ¼ −2:33 þ 2:29 VC þ0:10 Underwriter Reputation þ 11:86 Auditor Reputation

VC ¼ 0:73 þ0:09 Underpricing −0:02 Underwriter Reputation þ1:48 Auditor Reputation

Underwriter Reputation ¼ 19:39 þ3:98 Underpricing −19:24 VC þ0:20 Auditor Reputation

Auditor Reputation ¼ −0:01 þ 0:02 Underpricing þ 0:08 VC −0:00002 Underwriter Reputation

5. Further analysis of the performance of VC-backed IPOs in China

Speciﬁcally, we estimate the following regression:

IPO Performance ¼ α þ β1ΔVC Holding þ β2VC Syndicate

Variable Model 1 Model 2 Model 3 Model 4

Constant 1.60 1.912 6.153 5.658

Variable M3 MCAR M6 MCAR MCAR1 MCAR2 MCAR3

Constant 0.175 −0.806 −0.843 −2.557 −2.370

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