Venture Capital Investments by IPO Underwriters: Certification, Alignment of Interest or Moral Hazard?

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Abstract
We study IPO pricing when underwriters are venture capital investors in issuers and test three hypotheses concerning the effects of underwriter share ownership on the IPO underwriting and pricing processes. We find that venture investments by underwriters significantly reduce IPO underpricing; and the result is stronger for lead underwriters. This evidence is consistent with both underwriter certification and improved underwriter alignment of interests with issuers. The fall in underpricing is substantially greater when there is greater uncertainty about IPO valuation, which further supports the underwriter certification effect. Controlling for endogeneity effects does not change our conclusions. Finally, lead underwriter venture investment in IPO issuers also reduces underwriter gross spreads. Overall, the evidence is consistent with an underwriter certification effect and to a lesser degree an underwriter-issuer alignment of interest effect and inconsistent with an IPO conflict of interest effect.