The Hot and Cold Market Impacts on Underpricing of Certification, Reputation and Conflicts of Interest in Venture Capital Backed Korean IPOs

This article analyses the impact of the participation of venture capital (VC) firms on underpricing in 372 Small and Medium-Sized Enterprises (SMEs) brought to Initial Public Offering (IPO) during the period 1999-2001 in KOSDAQ. This period shows a stark contrast in the stock price movements in a way that hot market is abruptly followed by cold market, thus providing a good testing ground for empirical analysis to compare VC impacts in both markets. In this article, it was hypothesised that VC-backing, the reputation of VCs and the institutional affiliation of VCs would have different impacts on IPO underpricing between hot and cold markets. The empirical findings are that the VC reputation and bank-affiliation of VCs reduced underpricing, but only in the period of cold market. On the contrary, it appears that the conventionally hypothesized relationship between VC effects and less underpricing, based on information asymmetry theories, was not found in the hot market. On the contrary, security-company-affiliation of VCs that were expected to cause conflict of interests led to less underpricing in the hot market. I argue that prospect theory proposed by Loughran and Ritter (2002) could be a better framework to account for this conflicting results found in the hot market. The empirical results for impacts of offer price revision on the underpricing clearly show that highly sought-after stocks experienced greater underpricing in the hot market.