Management Quality, Venture Capital Backing, and Initial Public Offerings

In the paper, Management Quality, Venture Capital Backing, and Initial Public Offerings, which was recently made publicly available on SSRN, we use hand-collected data on the quality and reputation of the management teams of a large sample of 3,240 entrepreneurial firms going public during 1993-2004 to conduct the first large-sample study of the relationship between VC-backing and management quality and the effect of these two variables on a firm’s IPO characteristics and valuation, post-IPO financial policies, and post-IPO operating performance. We hypothesize that VC-backing positively affects the quality of a firm’s management team, and that both management quality and VC-backing play a certifying role in conveying a firm’s intrinsic value to the financial market, reducing the information asymmetry faced by it.

Our empirical findings are as follows. First, we find that overall VC-backed firms have higher quality management teams compared to non-VC-backed firms. In particular, VC-backed firms have a greater percentage of management team members with MBA degrees, a greater percentage of managers with prior managerial experience, a greater percentage of managers in core functional areas (operations and production, sales and marketing, R&D, and finance), and larger management teams compared to non-VC-backed firms. At the same time, VC-backed firms have lower percentages of management team members who are CPAs and who have prior managerial experience at law and accounting firms; further, their managers have shorter average tenures and smaller heterogeneity in these tenures.

Second, we find that both management quality and VC-backing have a positive effect on underwriter reputation and IPO offer size, and a negative effect on underwriting spread and other offering-related expenses. Further, management quality and VC-backing act as substitutes in their effect on the above IPO characteristics. Third, we find that both management quality and VC-backing have a positive effect on the analyst coverage of firms immediately after their IPO and on institutional investor interest in IPO firm shares. We also find that management quality and VC-backing act as substitutes in their effect on the extent of participation of the above-mentioned financial market players in IPOs. Fourth, we find that firms with higher management quality and firms backed by VCs are able to access the financial market earlier in their life cycle (at a younger age). Fifth, we find that both management quality and VC-backing have a positive effect on firm valuations both in the IPO market and in the secondary market immediately after the issue and they act as complements in affecting firm valuations.

Our study of the relationship between management quality, VC-backing, and firms’ post-IPO investment and financial policies as well as their post-IPO operating performance reveals several interesting findings. First, both management quality and VC-backing are associated with higher levels of post-IPO investment and they act as complements in this effect. Second, firms with high quality managers are associated with lower levels of leverage in the years after the IPO. Third, both management quality and VC-backing have a positive effect on the total value of acquisitions implemented by IPO firms after the IPO. Finally, although both high management quality and VC-backed firms are associated with lower levels of post-IPO operating performance (perhaps due to going public earlier in their life cycle and due to higher levels of post-IPO investment compared to firms with lower management quality or non-VC backed firms), we find that high management quality and VC-backing positively affect the changes in a firm’s post-issue operating performance. We also find that management quality and VC-backing act as complements in their effect on these changes in post-IPO operating performance.

The above findings add to our knowledge of the role played by VCs on the management quality of firms going public, and the joint effect of management quality and VC-backing on various aspects of a firm’s IPO, its interactions with the financial market, its firm valuation, its financial and investment policies, and its post-IPO operating performance. We find that management quality is an important determinant of firm quality even in VC-backed firms. Further, while in some cases management quality acts as a substitute for VC-backing, in other cases it acts as a complement to VC-backing.

The full paper is available for download here.