Do VC-backed IPOs manage tone?

ABSTRACT

This paper examines how and why VC-backed firms manage their tone during initial public offerings (IPO) and seasoned equity offerings (SEO). Analysis conducted using the Management Discussion and Analysis section of the prospectuses from 1997 to 2011 show that VC-funded firms are less optimistic in tone. VC-financed firms do so to reduce litigation risks and protect their reputational capital; the effect of conservative tone management is more pronounced when they hire large auditors, receive more analyst coverage, operate in high-tech sectors and in industries with high litigation risk. Further, tone is not related to the conveying of private information as IPO firms that received VC funding experience larger surprise unexpected returns and perform better than non-VC-backed offers in the long run.

KEYWORDS:

• Equity offerings
• venture capital
• litigation
• textual analysis

JEL CLASSIFICATIONS:

• G14
• G24
• K22

Acknowledgements

The author thank two anonymous referees, participants of the Econometrics and Financial Data Science Workshop (Reading, 2017), BAFA (London, 2017), EAA (Milan, 2018) and FMA (Norway, 2018), Nikolaos Antypas, Michael P. Clements, Ufuk Güçbilmez, Andreas Hoepner, Ivan Lim, Carol Padgett, Chao Yin and Yeqin Zeng for valuable comments and suggestions to this paper. All remaining errors are mine.

Disclosure statement

No potential conflict of interest was reported by the author.

ORCID

Tiffany Thng http://orcid.org/0000-0002-8954-0534

Notes

1 Usually 180 trading days from the IPO.

2 35% of these firms are not VC-backed at IPO.

3 SEC mandates firms to provide regulatory filings on EDGAR starting 1996. To ensure that firms are not excluded, I start the sample from 1997. Firms usually issue SEOs within 1 year (Spiess and Pettway 1997) to 3 years after an IPO (Jegadeesh, Weinstein, and Welch 1993). An average of the two is taken.

4 Loughran and McDonald (2013) suggest that to fully analyse narrative, it is advisable to parse a part of a text to serve its purpose. Since this section confirms information on the current health of the firm and prospects of the firm and is considered the least to be drafted by the syndicate, there is more freedom for management to provide their opinion on the firm.

5 Twelve firms or 1.85% of the sample in this paper. For follow-on issues, firms that are larger than US$300 million are not required by SEC to disclose certain information in the prospectuses (i.e. management team and MD&A). MD&A disclosures typically do not vary much between prospectuses and annual reports (e.g. Asbury Automotive Group, Inc., CIK#1144980).

6 The comprehensive lists can be found at http://www3.nd.edu/∼mcdonald/Word_Lists.html

7 http://fjavieralba.com/basic-sentiment-analysis-with-python.html.

8 For example, a negative token carries the score of −1. If an incremeter (decrementer) word precedes this token, the score becomes −2 (−0.5).

9 Adopted from Loughran and McDonald (2013).

10 A firm may be funded by more than one venture capitalist.

11 For a non-VC-backed firm, its MD&A contains an average of 8800 words, lending support to Boone, Floros, and Johnson (2016) study which documents that VC-backed firms disclose lesser information due to proprietary business data.

12 Jain and Kini (1995), Krishnan et al. (2011) and Hochberg (2012) document the contrary in which VC-backed firms receive more proceeds. In my study, the proceeds are less fees and expenses and could possibly explain the contrast.

13 VC IPO, VC Stay or VC SEO.

14 There are five VC firms reported in the table each year which is variant across time and can be found at https://www.cbinsights.com/blog/investor-league-tables-10-years-top-investors/.

15 https://site.warrington.ufl.edu/ritter/ipo-data/.

16 SEOs tend to have offer prices clustered in multiples of $0.25. Explanations offered for price clustering are the uncertainty in pricing these offers and the underwriters' reluctance in the price negotiation process. See Corwin (2003).

17 http://securities.stanford.edu/.

18 At the mean value of net tone of the entire sample, −0.095, the probabilities of being litigated successfully is −66.2% and −32.3% for non-VC- and VC-backed firms, respectively.

19 I thank an anonymous referee for pointing this alternate explanation.

20 Year fixed effects are more relevant in this estimation model as compared to PostSOX dummy used to the main regression. This is to reduce concern that the effect VC has on MBE is the result of timing and market conditions.

21 In an unreported test, results are similar when tone is replaced by Uncertain Tone. The resulting coefficient is 0.859 at the 10% significance level.

22 All one-to-one matching is done with replacement.