The Impact of Political Corruption, Firm Concentration, and Venture Capitalists’ Monitoring Failures on the Performance of U.S. IPOs

Abstract

One of the most prominent characteristics of the public capital market is information asymmetry. During the process of going public, the asymmetric information exists between insiders (e.g., issuers) and outsiders (e.g., investors) because there is very limited public information about issuers when they operated as private firms. This will result in the uncertainty of firm values and consequently lead to IPO underpricing, which is a market anomaly when the share is priced under its intrinsic value. In this case, newly listed firms experience losses, as they are potentially able to raise more capital (e.g., with higher offer price sold). Apart from the short-run performance around the offering, over 30% of IPO firms cannot survive longer than five years after going public. There are either acquired by other firms or delisted due to any negative factors (e.g., bankruptcy). Nevertheless, investors can take advantage of specific firm characteristics at the time of the offering to gain further valuation in order to anticipate the issuer’s future performance. Moreover, IPO is deemed as the most attractive way for venture capitalists (VCs) to exit their portfolio firms, as the return is substantially higher than M&As. As a special private fundraising entity, VCs’ reputation and expertise are important for IPO’s short-run and long-run performance.

Therefore, in this thesis, I examine the potential factors that affect an IPO’s performance in different time horizon (e.g., short- and long- run). Specifically, I first question how political corruption affect firms’ initial public offerings. Then, I investigate the relationship between a firm’s geographically dispersed business interests at the time of going public and its post-IPO survivability. Lastly, I explore the impact of VCs’ monitoring failures of previously backed IPOs on the performance of future supported newly listed firms.

First, I investigate the association between corruption and IPO underpricing. I find evidence that a politically corrupt environment increases underpricing and thereby imposes costs on firms that wish to access the initial public offering (IPO) market. The evidence indicates that the corruption effect applies only for small-sized issuers; moreover, the effect increases as the percentage of a firm's operations concentrated around its headquarter locations becomes greater. Further, I demonstrate that underwriters play a vital role in promoting IPOs in a corrupt environment by increasing offer price revisions and reducing underpricing. Additionally, political corruption does not diminish the likelihood of pre-IPO shareholders' achieving wealth gains, but does reduce post-IPO financial performance. Overall, empirical evidence supports the notion that political corruption causes business uncertainty and a high degree of information asymmetry in the market.

Second, I explore the impact of geographic dispersion on IPO’s survivability. Using a text-based measure as proxy for a firm’s geographically dispersed business interests, I document that geographic dispersion increases the probability of failure risk for newly listed firms. I find that the effect is more pronounced in a soft information environment where information is not easily transferrable or verifiable over long distances, and in small communities where managerial social concerns dominate in decision-making. Moreover, I find that firms with spatially distributed business interests are negatively associated with post-IPO operating performance. Overall, the results are consistent with the argument that geographically dispersed firms are subject to internal information asymmetry and divert managerial focus away from shareholder value, which negatively affects corporate performance and eventually results in corporate failure. Our study suggests to the corporate world, stay concentrated to survive.

Finally, I investigate how discredited VCs affect IPO performance. I define discredited VC as those who failed to monitor their backed IPOs and result in post offering litigations. I find discredited VC-backed IPOs experience higher underpricing and left more “money on the table”. Underwriters take advantage of offer price revisions to extract information from investors due to high information disparity. Further, IPO firms with discredited VCs exhibit declined post-IPO performance, as measured by operating return on assets and BHARs. Those IPOs are also associated with high failure risks. Lastly, I reveal it discredited VC-backed IPO with higher underpricing are less likely to face lawsuits, suggesting an insurance channel for the underpricing.

This thesis provides innovative evidence not only broadening up our scope to different areas of IPO related studies, but also contributing to a wide range of literature, including political corruption, firm’s geographic dispersion, and venture capital financing.

Importantly, studies included in this thesis may provide practical implications for different market participants (e.g., investors, regulators) to make efficient investment decisions.

Date of Award	2 Oct 2019
Original language	English
Awarding Institution	University of Bath
Supervisor	Dimitrios Gounopoulos (Supervisor) & David Newton (Supervisor)