Journal of Financial Risk Management, 2017, 6, 37-47
http://www.scirp.org/journal/jfrm
ISSN Online: 2167-9541
ISSN Print: 2167-9533

The Influence of Venture Capital Investment
on Underpricing of Second-Board Market IPO
Ling Wu
Department of Economics, Jinan University, Guangzhou, China

How to cite this paper: Wu, L. (2017). The
Influence of Venture Capital Investment on
Underpricing of Second-Board Market IPO.

Journal of Financial Risk Management, 6,37-47.
https://doi.org/10.4236/jfrm.2017.61004
Received: January 9, 2017
Accepted: March 7, 2017
Published: March 10, 2017

Copyright © 2017 by author andScientific Research Publishing Inc.
This work is licensed under the Creative
Commons Attribution International
License (CC BY 4.0).
http://creativecommons.org/licenses/by/4.0/
Open Access

Abstract
This study introduces venture capital investment as a variable in underpricing
of stock’s IPO. From the theoretical perspective, this study uses four points ofview—Certification, Supervision, Adverse selection and Grandstanding theory,
to explain the relationship of venture capital investment and underpricing of
IPO. In real empirical part, this study takes 125 second-board companies as asample to research on the relationship among venture capital investment, thecharacteristics of venture capital and underpricing of IPO. The finding showsthat in the second-board market, companies which have venture capital institutions involved show a higher IPO underpricing rate compared to the companies which have no venture capital institutions involved. The main findingis that there is irrational investment behavior in the market.

Keywords
Venture Capital, Second-Board Market, IPO Underpricing

1. Introduction
As of the end 2014, there are more than 400 companies listed on second-board
market, which have provided a new financing channel for many innovative small
and medium-sized enterprises. The IPO underpricing refers to the phenomenon
that closing price higher than the issue price in First-day. Among the first batchof 28 second-board market listed companies, the average underpricing rate is106.23%, the highest up to 209.73%. The high underpricing level will attract
people to purchase new shares, then use pricing discrepancies to arbitrage, thus
have negative effects on fund allocation of capital market.
Venture capital investment refers to a way of operation that the venture capital institutions invest innovative small and medium-sized enterprises in the formof purchasing shares, then, venture capital institutions participate the company’s
DOI: 10.4236/jfrm.2017.61004 March 10, 2017

L. Wumanagement to help it up to the IPO standard, after the company have positive
profits, its share price will rise and the venture capital institutions will sell theshares to get a capital gain. On the one hand, venture capital investment promoted the normal operation of second-board market, and became an importantchannel to solute financing difficulty of many small and medium-sized enterprises. On the other hand, second-board market provided the best exit channel
for venture capital; it made venture capital get involved in the capital market topromote innovative small and medium-sized enterprises’ development.

2. Literature Review
2.1. Certification Theory
Certification Theory is earliest proposed by American scholar Megginson &Weisss (1991). he called the positive tension that venture capital produced to
IPO enterprises as Certification Theory—like underwriter, venture capital havethe third party certification effect on IPO enterprises. As a shareholder, venture
capital institution will convey honesty information to public in order to protect
its reputation. So, if a company have venture capital institution as its stockholder, public investors will see it as a signal of high-quality company. This make theinvolvement of venture capital institution can reduce the degree of information
asymmetry between company and investors and help investors know more
about the company’s true value, then reduce the underpricing rate.

2.2. Supervision Theory
Barry et al. (1990) think if venture capital institutions with high proportion
share and occupying a certain seat on the board will play a supervisory role inthe company. It can make the underpricing degree of the companies which haveventure capital involved is lower than the companies which don’t have venture
capital involved. Barry C. B. called this phenomenon as Supervision Theory and
it is a supplement to the Certification Theory. On the one hand, in order to protect their own interests, venture capital institution will pay close attention to theoperating conditions of the invested enterprise. On the other hand, risk investment institutions can influence on the operating decision through its holdings ofshares and the rights of the board, then play a supervision role in the enterprise.

2.3. Adverse Selection Theory
In 1990, Amit, Glosteii and Muller (1990) first introduce “Adverse selection
Theory” to IPO underpricing. In this theory, there is exist information asymmetry between venture capital institutions and enterprise,—as an outside investor,
the information venture capital institutions grasped can not comprehensive andtrue, and it may cause deviation when evaluated the enterprise. In fact, this situation may cause the enterprises which venture capital institutions involved are
not high-quality enterprises, so these enterprises tend to choose a lower issuanceprice and caused a higher underpricing rate.
38

L. Wu2.4. Grandstanding Theory
American scholar Gompers (1996) proposed the Gradstanding Theory. In his
finding, compared to the enterprises which immature venture capital institutions involved in, the enterprises which mature venture capital institutions involved in shows a lower underpricing rate and have a better performance inother IPO indexes. Gompers think the reason of this phenomenon is venture
capital institutions need to raise money to maintain operations, but most of the
new venture capital institutions are lack of high reputation, in order to raise
more funds in the future, these institutions are crying out for success projects toenhance reputation in capital market. So these enterprises that immature venture capital institutions involved don’t choose the best opportunity to go public,
leading to the higher underpricing rate and dismal performance.

3. Research Methodology
3.1. Sample’s Selection and Data Sources
This study selected a total of 125 the second-board market listed companies
from 2012 to 2014 as sample. Through consulting the stockholder list in prospectus to check whether there exists venture capital institutions and its proportion of shareholding. All the prospectus are down from can explain this source alittle bit? Other data like IPO underpricing, IPO P/E ratio, turnover rate arefrom explain a little bit? it is a database created by some investment firm frommy memory. This study dividing these 125 companies into two sub-sample:
VC-Backed and NON-VC-Backed, then dividing “VC-Backed” sample into twogroups: VC-Rep-High and VC-Rep-Low. Specific steps are as follows: first, lookup the keyword like investment, venture investment, innovational investment inprospectus, if the company’s shareholders including venture capital institutions,
it will be classification to “VC-Backed” sample, otherwise will be classification to“NON-VC-Backed” sample. Second, refer to the China venture capital and private equity annual ranking 2014 by Zero2IPO Group, the companies which in
the list of “the ranking might be different from 2012 to 2014, why using 2014
and “Top 20 VC Firms of the Year 2014 (China)”, the study classified thesecompanies into “VC-Rep-High”. After classified the 125 companies, the subsample “VC-Backed” size is 105, sub-sample “NON-VC-Backed” size is 20, in
the sub-sample “VC-Backed”, the sample size of “VC-Rep-High” is 14 and thesample size of “VC-Rep-Low” is 91.

3.2. Variables’ Selection and Explanation
3.2.1. Explained Variables’ Selection and Explanation
This study selected IPO underpricing as explained variable. In consideration of
the influence of market quotation on IPO underpricing, this study chooses theadjusted IPO underpricing (AUp) as explained variable.

=
AUp

P1 − P0 M 1 − M 0
−
P0
M0
39

L. WuIn the above formula, can you explain this formula a little bit, any theory
backup or reason?, P1 refers to the first-day closing price, P0 refers to the IPO
price, M1 refers to the second-board closing index of first trading day, M0 refers
to the second-board closing index of issue day.
3.2.2. Explaining Variables’ Selection and Explanation
Would be better if there is some summary table of ALL variables, to give us ageneral picture of the dataset.
First, the participation of venture capital institutions. In this study, the companies in sub-sample “VC-Backed” average value of 1.
Second, the reputation of venture capital institutions. The companies in subsample “VC-Rep-High” average value of 1.
Third, the quantity of venture capital institutions. If the company’s shareholders including more than one institution, the fraud cases will be decreased insome degree.
Fourth, total shareholding ratio of venture capital institutions?. The total
shareholding ratio will send secondary market investors a message—the higher
shareholding ratio refers to the higher reduction ratio of shareholders, thus,
small investors will face the bigger risk and give the share lower valuations.
3.2.3. Control Variables Selected and Explanation
IPO underpricing can be influenced by various factors. Except for venture capital institutions, this study uses three other factors—basic status of the company,
market performance and shareholders’ profitability to select appropriate indexes, the specific indexes are as follow:
First, operation time. This variable refers to the year from company’s establish
to the stock be listed. To a certain extent, company’s operation years can reflect
its maturity level, the degree of recognition that market to company and amountof public information that investors can obtain.
Second, financing scale. In some degree, the bigger financing scale means thebigger company scale, large-scale company often establish a more completely
and standard system in information disclosure. The better information disclosure system can reduce the degree of information asymmetry between company
and investors, this will restrict opportunistic behavior to some extent and have apositive influence on IPO underpricing. This study use natural logarithm of financing amount to measure financing scale.
Third, first day price earnings ratio. To a certain extent, price earning ratio
can be a measuring indicator of speculation degree, when the price earning ratio
exceeds a certain value, the higher price earning ratio refers to the higher speculation degree. Price earning ratio have a big effect on the investors’ selection andthen influent IPO underpricing.
Fourth, first day turnover rate. This variable refers to the ratio of volume andissued amount, it reflect the frequency of investors trade new stocks. The highturnover rate means the investment deal is active, investors have a stronger desire of purchase. However, the high turnover rate always means a more specula40

L. Wutive atmosphere and have bad influence on IPO underpricing.
Fifth, the lottery rate of online distribution. The lottery rate is connected withFinancing volume of subscribe, it also reflect investors’ recognition degree to theissue price and investors’ mood. The lower lottery rate means the Larger amountof money, in this case, the investors who cannot purchase the new share willtransfer their requirements to secondary market, this can make the stock pricedeviate from the actual value and increase the transaction price, then affect IPO
underpricing.
Sixth, earnings per share. Generally speaking, earnings per share is the important index to measure investment value and risk, it also always be used tomeasure the management results of the company and as a important financial
index to evaluate the company’s profitability. This study choose the earnings per
share of the previous year.

3.3. Relationship of Venture Capital Investment andSecond-Board Market IPO Underpricing
This study chooses why this method not other econometric tools? Is this mean
test enough? to test the IPO underpricing and its influence index.
3.3.1. Relationship of Venture Capital and IPO Underpricing
This study divided the 125 companies into two groups–have venture capital involved and the opposite, then compare the average value of the two sub-samples’
IPO underpricing. The result is as follow:
Table 1 and Table 2 shows that, the average IPO underpricing of the companies which have venture capital involved is higher than the companies which
don’t have venture capital involved. In the Levene Test, F-sig is 0.973, exceed thesignificance level 0.05, so this study accept the assumption that the two groups’
variance is equal. The T-sig is 0.131, exceed the significance level 0.05, so thisTable 1. Group statistics.
VC

N

Mean

Std. Deviation

Std. Error Mean

Underpricing 1

1050.30262406

0.225184737

0.021975780

0200.22012552

0.204613536

0.045752978

Notes: group 1 is the company which have venture capital involved, the group 2 is the company which
don’t have venture capital involved.

Table 2. Independent samples test.
Levene’s Test for
Equality of Variances

F

Equal variances assumed
Equal variances not assumed

0.001

Sig.

0.973

t-test for Equality of Means

t

1.522

df

Sig.
Mean
(2-tailed) DifferenceStd. Error
Difference

95% Confidence Intervalof the Difference
Lower

Upper

123

0.131

0.08250.05419−0.02478

0.18977

1.625 28.501

0.115

0.08250.05076−0.02139

0.18639

41

L. Wustudy accept the assumption of the null hypothsis of two independent sample’s T
test—the IPO underpricing have nothing to do with the venture capital. On thegrowth enterprise board, venture capital has no had significant effects on IPO
underpricing, explain a little bit, is this conclusion surprised or against sometheories
3.3.2. Relationship between Venture Capital and Control Variable
There are many factors that affect IPO underpricing, like the basic informationof listed companies, market performance and shareholders. In order to ensure
the accuracy of research result, this paper choose the variables that related to
IPO underpricing as control variable, use independent-samples T test to compare the value, the purpose is to find the difference of financing scale, PE ratio,
turnover rate, win a label rate and earnings per share.
From Table 3, in vc-backed sample, the values of price earnings ratio, turnover rate and earnings per share are higher than non-vc-backed sample. Meanwhile, each variable’s significance level is less than 0.05. These values means
venture capital have no obvious influence on IPO underpricing.

3.4. Relationship between the Characteristics of Venture Capitaland IPO Underpricing
The companies that have venture capital’s support, the reputation, amount, andshareholding ratio of venture capital institution called the characteristics of venture capital. This paper use independent-samples T test, Spearman rank correlation analysis and Pearson product-moment correlation to research the relationship between venture capital and IPO underpricing. This chapter choose VCBacked sample—the 105 companies that have venture capital institution involved
as research object.
Table 3. Relationship between venture capital and control variable.
Mean value
operation timefirst day priceearnings ratio

financing scale

first day turnover rate

the lottery rateof online distribution
earnings per share

42

VC-Backed

11.92250

NON-VC-Backed

12.71164

VC-Backed

30.98114

NON-VC-Backed

28.20900

VC-Backed

19.68185

NON-VC-Backed

19.80048

VC-Backed

3.092736

NON-VC-Backed

0.395905

VC-Backed

1.314509

NON-VC-Backed

1.391680

VC-Backed

1.208829

NON-VC-Backed

0.98870

T-valuesignificance level−0.760

0.449

1.102

0.273

−0.969

0.335

−0.04

0.968

−2.83

0.777

1.287

0.200

L. Wu3.4.1. Relationship between the Reputation of Venture Capital
Institution and IPO Underpricing
This chapter choose independent-samples T test to research the relationshipbetween the reputation of venture capital institution and IPO underpricing. For
the companies in high reputation list, it’s value of VC-Rep is 1, otherwise thevalue is 0. The result is as follow:
From the mean of IPO underpricing, the value of VC-Rep-H sample is higher
than VC-Rep-L sample. From the Table 4 and Table 5, we can know that in
Growth Enterprises Market, the companies which have high reputation venture
capital institution involved show a lower IPO underpricing, but this variable
have a weak influence on IPO underpricing. So grandstanding theory haven’t
been confirmed on Growth Enterprises Market.
3.4.2. Relationship between Amount of Venture Capital Institution and
IPO Underpricing
After consult the prospectus of 105 companies in VC-Backed sample, we cancalculated out the amount of venture capital institution in each companies’
shareholder list. Because of the amount of venture capital institution is discretevariable, this paper choose Spearman rank correlation analysis to research therelationship between amount of venture capital institution and IPO underpricing. The result is as follow Table 6.
We can find negative correlation between amount of venture capital institution and IPO underpricing, the coefficient is −0.14, but Sig. (1-tailed) is 0.078,
this mean the relationship between amount of venture capital institution and
IPO underpricing is insignificant.
3.4.3. Relationship between Shareholding Ratio of Venture Capital
Institution and IPO Underpricing
This paper use Pearson product-moment correlation to research the relationshipbetween shareholding ratio of venture capital institution and IPO underpricing,
the result is as follow:
Table 4. Comparison of IPO underpricing.
Rep
IPO underpricing

N

Mean

Std. Deviation

Std. Error Mean

091

0.305923

0.2161072

0.0226542

1

140.281179

0.2859546

0.0764246

Table 5. Independent-samples test.
Levene’s Test for
Equality of Variances
F

IPO
underpricing

Equal variances
assumedEqual variances
not assumed

1.711

Sig.

t-test for Equality of Means

t

df

Sig.
Mean
(2-taile d) DifferenceStd. Error
Difference

Confidence Intervalof the Difference
Lower

Upper

0.381

103

0.704

0.0247445

0.0649144−0.1039978 0.1534868

0.310

150.3680.760

0.0247445

0.0797115−0.1448032 0.1942921

0.194

43

L. WuTable 6. Correlations of Spearman.
amount ofIPO
venture capital
underpricing
institution
amount of venture
capital institution
Spearman’s rho
IPO underpricing

Correlation Coefficient

1.000−0.140Sig. (1-tailed)

-

0.078

N

105

105

Correlation Coefficient−0.1401.000

Sig. (1-tailed)

0.078

-

N

105

105

Table 7 show us a negative correlation between shareholding ratio of venture
capital institution and IPO underpricing. The Sig. (1-tailed) is 0.040, means ahigher shareholding ratio of venture capital will lead to a lower IPO underpricing. This conclusions supported certification theory and supervision theory–thehigher shareholding ratio of venture capital means a higher degree of participation that venture capital manage company, so venture capital institution can supervise company. But supervisory role only because the shareholding ratio ofventure capital represent the ratio of reducing holding-shares after lock-up period. Investors in secondary market can forecast the loss because of reducing
holding-shares, so they will not overestimate the value of stocks.

3.5. Multivariate Regression Analysis of Venture Capital and
IPO Underpricing
This paper choose IPO underpricing as explained variable and use multivariate
regression analysis to research the correlation between IPO underpricing and its
influencing factor.
There are three model in this paper, model 1 is to explain the not only correlation, might also show some causal relationship? Between IPO underpricing
and its influencing factor, model 2 is to explain the correlation between IPO underpricing and venture capital, model 3 is to analyze the correlation between
IPO underpricing and venture capital’s characteristics.
Model 1: AUp = β0 + ∑βi *C variablesi + ε
Model 2: AUp = β0 + β1 *VC + ∑β i *C variablesi + ε
Model 3: AUp = β0 + β1 *VC Rep + β2 *VCNum + β3 *VCShare + ∑βi *Cvariablesi + εIn model 1, βi (i = 1, 2,…,7) means the coefficient of each control variable andCvariables i (i = 1, 2,…,7) means control variables. In model 2, β1 means the degree of venture capital participate in company, and βi (i = 1, 2, …, 8) means thecoefficient of each control variable. In model 3, β1 means the reputation of venture capital institution, β2 means the amount of venture capital institution and β3
means the shareholding ratio of venture capital institution. βi (i = 4, 5, ……, 10)means the coefficient of each control variable.
44

L. WuTable 7. Correlations of Pearson.

IPO underpricing

shareholding ratioof venture
capital institution

IPO underpricing

shareholding ratio ofventure capital institution

Pearson Correlation

1−0.172*Sig. (1-tailed)

-

0.040

N

105

105

Pearson Correlation−0.172*

1

Sig. (1-tailed)

0.040

-

N

105

105

*Correlation is significant at the 0.05 level (1-tailed).

3.5.1. Can You Show the Results of 3 Regressions in One Table? To Make
Comparison Easier. Pls Also Show R2 of F Stats
From Table 8, we can know that there didn’t show severe multicollinearity problem. Among the control variables, financing scale and lottery rate of online distribution have significant correlations with IPO underpricing. The coefficient offinancing scale is −0.147, means a negative correlation. On Growth Enterprises
Market, the bigger financing scale means the bigger enterprise scale. Big enterprise have normal management, gained extensive attention of investors, thesecompanies’ information are more transparent, so these companies have a lower
IPO underpricing. The coefficient of lottery rate of online distribution is −0.063,
means a negative correlation. The lower lottery rate of online distribution means
the demand for these stocks exceeds the supply on the market. So these stocks
will be deal frequently on the first day, this will lead to the transaction value ofthese stocks higher than it’s actual value, and finally show a high IPO underpricing.
3.5.2. Result of Model 2
From Table 9, we can know that there didn’t show severe multicollinearity. The
coefficient of venture capital is 0.050, which means a positive correlation. The
company which has venture capital institutions involved always show a higher
IPO underpricing, this can verify that certification theory and supervision theory
didn’t play a role on Growth Enterprises Market.
3.5.3. Result of Model 3
From Table 10, the reputation of venture capital institutions no coefficient with
IPO underpricing, so grandstanding theory didn’t play a role on Growth Enterprises Market.

4. Conclusions
After theoretical research and empirical analysis, the conclusions are as follow:
first, certification theory and supervision theory didn’t play a role on GrowthEnterprises Market; second, the reputation of venture capital institutions haveweak influence on IPO underpricing; third, the real reason of IPO underpricing
is speculation and blindness in investment in secondary market.
45

L. WuTable 8. Coefficient of Model 1.

Model

Unstandardized
Coefficients

Standardized
Coefficients

t

Sig.

Collinearity
Statistics

B

Std. Error

Beta

Tolerance VIF(Constant)

3.147

0.800

-

3.932

0.000

-

-

operation time

0.002

0.004

0.043

0.511

0.611

0.906

1.104

price earnings ratio

0.000

0.002

0.017

0.168

0.867

0.648

1.542

financing scale−0.1470.041−0.330−3.568

0.001

0.761

1.314

turnover rate

0.006

0.061

0.009

0.097

0.923

0.811

1.233

lottery rate ofonline distribution−0.0630.019−0.312−3.250

0.002

0.709

1.411

earnings per share

0.070

0.031

0.219

2.230

0.028

0.678

1.476

Standardized
Coefficients

t

Sig.

Collinearity
Statistics

Table 9. Coefficient of Model 2.

Model(Constant)

Unstandardized
Coefficients
B

Std. Error

Beta

2.993

0.816

-

3.666

0.000

Tolerance

VIF

-

-

operation time

0.003

0.004

0.049

0.576

0.566

0.901

1.109

price earnings ratio−5.683E−5

0.002−0.003−0.026

0.980

0.624

1.604

financing scale−0.141

0.042−0.316−3.367

0.001

0.742

1.348

turnover rate

0.008

0.061

0.012

0.133

0.895

0.810

1.235

lottery rate ofonline distribution−0.0610.019−0.301−3.117

0.002

0.699

1.430

earnings per share

0.062

0.032

0.196

1.940

0.055

0.641

1.561

venture capital

0.050

0.051

0.082

0.972

0.333

0.921

1.086

Sig.

Collinearity
Statistics

Table 10. Coefficient of Model 3.

Model

46

Unstandardized
Coefficients

Standardized
Coefficientst

B

Std. Error

Beta

Tolerance

VIF(Constant)

2.761

1.060

-

2.604

0.011

-

-

operation time

−0.001

0.005−0.024−0.249

0.804

0.878

1.140

price earnings ratio

0.000

0.002

0.013

0.112

0.911

0.617

1.621

financing scale−0.1230.055−0.258−2.219

0.029

0.626

1.597

turnover rate

0.003

0.071

0.004

0.038

0.969

0.793

1.261

lottery rate ofonline distribution−0.0630.022−0.316−2.0817

0.006

0.671

1.490

earnings per share

0.061

0.038

0.198

1.0605

0.112

0.555

1.802

reputation−0.0170.064−0.026−0.272

0.786

0.897

1.115

amount−0.0020.013−0.021−0.164

0.870

0.517

1.936

shareholding ratio

0.000

0.001

−0.095−0.804

0.423

0.602

1.660

L. WuTo cure the above problems, there are four advices: First, improve the qualityof venture capital institutions. As a venture capital institution, it needs to pay
close attention to long-term development of enterprise, like cultivate professional personnel, provide value-added services for the enterprise. Second, perfectevaluation system of the reputation of venture capital institution. A perfectevaluation system can urge venture capital institutions to constantly improve its
ability. This will be good for establishing positive market competition mechanism. Third, it can improve the quality of listed company. Before choosing a venture capital institution, the company needs to measure its circumstance and thebackground of venture capital institution. After getting the venture capital, thecompany needs to seek help of venture capital institution actively to improve
management mode, innovative ability and service level. Fourth, instruct investors to be rational. Investors need to accumulate investment knowledge and cultivate logical thought, this can help reduce the blind investment behavior.

References
Amit, R., Glosten, L., & Muller, E. (1990). Entrepreneurial Ability, Venture Investment,
and Risk Sharing. Management Science, 36, 1232-1245.
https://doi.org/10.1287/mnsc.36.10.1233
Barry, C. B., Muscarella, C. J., Peavy, J. W. et al. (1990). The Role of Venture in the Creation of Public Companies. Journal of Financial Economics, 27, 447-471.
https://doi.org/10.1016/0304-405X(90)90064-7
Gompers, P. A. (1996). Optimal Investment, Monitoring, and the Staging of Venture
Capital. Journal of Finance, 50, 1461-1489.
https://doi.org/10.1111/j.1540-6261.1995.tb05185.x
Megginson, W., & Weiss, K. (1991). Venture Capitalist Certification in Intial Public Offerings. The Journal of Finance, 46, 879-903.
https://doi.org/10.1111/j.1540-6261.1991.tb03770.x

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