206 S. Drucker and M. Puri
Using a sample of 885 venture-backed IPOs from December 1972 to December 1992,
Gompers and Lerner (1999)compare long run performance, liquidation probability, and
underpricing based on if an underwriter in the IPO holds a venture stake. To examine
long-run performance,Gompers and Lerner (1999)calculate the 5-year buy-and-hold
excess return, which is the firm’s buy-and-hold return minus the 5-year buy-and-hold
return of the portfolio of firms with the same size and book-to-market ratio. This com-
parison reveals that issues where the investment bank held an equity stake perform just
as well, and by some measures significantly better than, non-affiliated offerings. These
results are inconsistent with the existence of conflicts of interest. Further, the authors
explore if excess returns are influenced by the percentage of venture investors’ equity
sold at the time of the IPO. If venture investors are attempting to take advantage of
outsider investors, then higher fractions of equity sold should result in lower excess re-
turns. They find no evidence to support this hypothesis, and in fact, find the opposite to
be true. In addition,Gompers and Lerner (1999)examine the probability that a firm is
liquidated within 5 years of the IPO and find no significant relationship between liqui-
dation probability and using an underwriter that has a venture claim in the firm. Again,
these results suggest that conflicts of interest are not a concern. Further supporting this
view, when examining underpricing, the authors do not find a significant difference
between IPOs that are underwritten by affiliated underwriters and independent under-
writers.
Li and Masulis (2004)also examine the impact of venture capital investments by IPO
underwriters on the net certification ability of the underwriter. However, as opposed
toGompers and Lerner (1999)who treat all existing venture relationships as equally
important,Li and Masulis (2004)examine if the size of the equity ownership by the
underwriter affects IPO underpricing and the probability of being delisted in the future.
This approach is similar to that inGande et al. (1997). Using a sample of 1,480 venture-
backed IPOs from 1993 to 2000, the authors find that IPO underpricing decreases as the
share of the underwriter’s equity ownership increases, even after controlling for other
factors that can influence underpricing. The underpricing results are consistent with
certification effects overriding any conflicts of interest. In support, the authors find that
among issues that are more uncertain, which is proxied for by the firm’s stock volatility
during the year following IPO, venture investments reduce underpricing more than for
less risky issues. This suggests that the prior information from the venture investment
allows the underwriter to reduce informational asymmetries. Similar toGompers and
Lerner’s (1999)evaluation of liquidation,Li and Masulis (2004)find no significant
relationship between underwriter shareholdings and the likelihood of subsequent stock
delisting, which is consistent with conflicts of interest not being pronounced.
The evidence in these two studies highlight that conflicts of interest are not a concern
when an underwriter holds an equity stake in the firm. Further, the analysis inLi and
Masulis (2004)suggests there are benefits from the underwriter holding an equity stake,
with affiliated underwriters being net certifiers of firm value and allowing for firms to
reduce their direct costs of going public.