Rossetto, Silvia. (2008) The price of rapid exit in venture capital-backed IPOs. Annals of Finance, Vol.4 (No.1). pp. 29-53. ISSN 1614-2446

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Abstract

This paper proposes an explanation for two empirical puzzles surrounding initial public offerings (IPOs). Firstly, it is well documented that IPO underpricing increases during “hot issue” periods. Secondly, venture capital (VC) backed IPOs are less underpriced than non-venture capital backed IPOs during normal periods of activity, but the reverse is true during hot issue periods: VC backed IPOs are more underpriced than non-VC backed ones. This paper shows that when IPOs are driven by the initial investor’s desire to exit from an existing investment in order to finance a new venture, both the value of the new venture and the value of the existing firm to be sold in the IPO drive the investor’s choice of price and fraction of shares sold in the IPO. When this is the case, the availability of attractive new ventures increases equilibrium underpricing, which is what we observe during hot issue periods. Moreover, I show that underpricing is affected by the severity of the moral hazard problem between an investor and the firm’s manager. In the presence of a moral hazard problem the degree of equilibrium underpricing is more sensitive to changes in the value of the new venture. This can explain why venture capitalists, who often finance firms with more severe moral hazard problems, underprice IPOs less in normal periods, but underprice more strongly during hot issue periods. Further empirical implications relating the fraction of shares sold and the degree of underpricing are presented.

Item Type:	Journal Article
Alternative Title:	The price of rapid exit in venture capital-backed initial public offerings
Subjects:	H Social Sciences > HG Finance
Divisions:	Faculty of Social Sciences > Warwick Business School
Library of Congress Subject Headings (LCSH):	Going public (Securities), Venture capital, Noncooperative games (Mathematics), Information asymmetry, Financial risk
Journal or Publication Title:	Annals of Finance
Publisher:	Springer
ISSN:	1614-2446
Date:	January 2008
Volume:	Vol.4
Number:	No.1
Page Range:	pp. 29-53
Identification Number:	10.1007/s10436-006-0065-8
Status:	Peer Reviewed
Access rights to Published version:	Open Access
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URI:	http://wrap.warwick.ac.uk/id/eprint/2690

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