Venture Capital and Underpricing: Capacity Constraints and Early Sales

I present a new theory about underpricing and Venture Capital-backed (VC-backed) companies where the key feature is capacity constraints - Venture Capital firms can take only a limited number of new projects. This new theory predicts that younger Venture Capitalists rush to Initial Public Offerings (IPOs) and sell below the market price. Moreover, the model predicts the positive impact of hot issue markets and technological cost saving shocks on underpricing. The latter features are absent in existing models, and our findings are consistent with the data. Finally, the model presents a microfounded auction model to underpricing in IPOs with random arrival of potential buyers. It generates testable implications on the impact of time between registration to an IPO and firm age on underpricing. I present preliminary empirical results that support the theoretical predictions.

For more information, contact Dirk Krueger.