The Role of Venture Capital (Vc) in the Underpricing of European Life Science Companies

(ProQuest: ... denotes formulae omitted.)IntroductionThe empirical literature commonly finds that firms are underpriced at the time of IPO, generating a positive return after the first day of trading. The underpricing is explained, among other theories, by the asymmetries of information characterising the debuting firms. Despite this holds in general, the literature often finds that VC backed companies have a lower underpricing at IPO, thanks to the certification role of the venture capitalists.This study evaluates the performance at IPO of a sample of European firms operating in the life science industry that were listed in the period 2002-2007. We focus on the life science industry because it represents an important source of investment opportunities for venture capitalists given the strong and relevant innovative content of their activity, which is, however, also characterized by potential risks and threats for the investors, as the functioning of the sector is severely affected by regulation and ethical concerns. In fact, according to the EVCA data (EVCA, 2013), life science business attracted around 25% of investments in 2007 and this figure has been growing considerably in the latest years (in 2013 it reached 37.1%). The same holds in terms of number of firms receiving VC in this industry, which represented the 19.2% of the total VC backed firms in 2007 (22.9% as at end 2013).Besides, we limit the sample at 2007 to eliminate possible effects of the financial crisis that hit the markets after 2008.Empirical evidence shows a strong statistical difference in the performance of VC backed and non VC backed companies. Both groups of firms exhibit underpricing for the first day and for the first week of trading, but VC backed firms outperform the other companies.This research contributes to the literature providing further insight on the underpricing phenomenon for a relevant and innovative industry, such as the life science business; additionally, it delivers further evidence on the role of venture capital at the time of IPO for European firms.The rest of the paper is structured as follows: Section 1 discusses the previous contributions provided by the literature; Section 2 presents the methodology; Section 3 analyses the results and the last section concludes.1. Theoretical backgroundEmpirical literature finds that on average the offering price at the time of IPO for a firm is below the price that prevails on the first trading day (Ibbotson and Ritter, 1995). This phenomenon is called underpricing and might generate positive large returns not only in the first days, but also in the first weeks of trading.The explanation of these large positive returns is linked to the asymmetry of information affecting the listing firm, which generally is not well known to the public of investors (see Ibbotson and Ritter, 1995, for a complete survey of the theories explaining underpricing).Part of the wide literature on underpricing acknowledges that the contribution of VC can soften this phenomenon: VC backed firms present a lower underpricing if compared to other companies, thanks to the presence of specialized investors (Megginson and Weiss, 1991), as the latter have the ability to reduce the asymmetries of information in young debuting companies (Gompers, 1996; Jain and Kini, 2000). In fact, venture capitalists perform screening and monitoring activities that enable them to select only the best business ideas and to constantly improve the management of the firm, boosting its performance (Kaplan and Stromberg, 2001). The relevance of the screening and monitoring phases implemented by the venture capitalists is confirmed by Chemmanur and Loutskina (2006) who also suggest that VC backed IPOs have a lower underpricing because the venture capitalists are able to attract more and better investors in the market, such as institutional investors. Despite the strong theoretical argument, a number of studies finds contrasting evidence: according to Brau et al. …