Papers
Local Bias in Venture Capital Investments
Journal of Empirical Finance, Forthcoming. Co-authored with Douglas Cumming
This paper examines local bias in the context of venture capital (VC) investments. Based on a sample of US VC investments between 1980 and June 2009, we find more reputable VCs (older, larger, more experienced, and with stronger IPO track record) and VCs with broader networks exhibit less local bias. Staging and specialization in technology industries increase VCs’ local bias. We also find that the VC exhibits stronger local bias when it acts as the lead VC and when it is investing alone. Finally, we show that distance matters for the eventual performance of VC investments.
LikeThe Choice of Equity Selling Mechanisms: PIPEs versus SEOs
Journal of Corporate Finance, Forthcoming. Co-authored with Hsuan-Chi Chen and John Schatzberg
We examine the firm's choice between an SEO and a PIPE, an innovation in follow-on equity selling mechanism seen in the late 1990s. Our primary finding indicates that the rapid rise of the PIPE market fills the capital needs of firms which may not have access to more traditional alternatives. This lack of access is driven mainly by information asymmetry and weak operating performance. We also show that firms are more likely to choose PIPEs when the general market and the firm's stock are performing poorly. Furthermore, we find that selected firms with access to the public market may prefer a PIPE due to specific cost considerations.
The Quality and Price of Investment Banks' Service: Evidence from the PIPE Market
Financial Management, Forthcoming. Co-authored with Hoje Jo and John Schatzberg
We investigate the market structure and the pricing by placement agents of private investments in public equities (PIPEs). Our findings indicate that more reputable agents associate with larger offers and with firms possessing lower risks. Agent reputation is positively associated with lower discounts and an enhanced post-PIPE trading environment. We also observe support for the hypothesis that issuers pay a dollar fee premium for these benefits. The evidence suggests that it is the quality of the issuing firm, in conjunction with the pricing and reputational concern of the placement agent, that drive the equilibrium in the PIPE market.
Does Investor Identity Matter? An Empirical Examination on Investments by Venture Capital Funds and Hedge Funds in PIPEs
Journal of Corporate Finance, Vol. 13, 2007
I examine the emerging phenomenon of PIPEs (private investments in public equity) invested by venture capital funds (VCs) and hedge funds (HFs) and analyze whether and how these investors add value to firms by comparing a sample of 113 VC-invested PIPEs to a sample of 397 PIPEs with HFs. I find that VCs gain substantial ownership, request board seats, and often keep their stake after the PIPEs. In contrast, HFs rarely join the board of directors and typically cash out their positions shortly after the PIPE. The stock performance of VC-invested firms is significantly better than HF-invested firms both in the short run and in the long run. The positive valuation effect of having VCs as PIPE investors appears to be a certification effect rather than a monitoring effect. A key implication from these findings is that investor identity matters.
Capital Flows and Hedge Fund Regulation
Journal of Empirical Legal Studies, Forthcoming. Co-authored with Douglas Cumming.
This paper introduces a cross-country law and finance analysis of the flow-performance relationship for hedge funds. The data indicate that distribution channels in the form of private placements and wrappers mitigate the impact of performance on fund flows. Distribution channels via investment managers and fund distribution companies enhance the impact of performance on fund flows. Funds registered in countries which have larger minimum capitalization requirements for funds have higher levels of capital flows. Funds registered in countries which restrict the location of key service providers have lower levels of capital flows. Further, offshore fund flows and calendar effects evidenced in the data are consistent with tax factors influencing fund flows. Our findings are robust to Heckman-selection effects for offshore registrants, among other robustness checks.
A Law and Finance Analysis of Hedge Fund
Financial Management, Forthcoming. Co-authored with Douglas Cumming
This paper empirically analyzes the impact of hedge fund regulation on fund structure and performance using a cross-country dataset of 3782 hedge funds from 29 countries. The data indicate regulatory requirements in the form of restrictions on the location of key service providers and permissible distributions via wrappers (securities that combine different products) tend to be associated with lower manipulation-proof performance measures, lower fund alphas, lower average monthly returns (as well as lower Sharpe ratios), higher fixed fees and lower performance fees. Also, the data show standard deviations of monthly returns are lower among jurisdictions with restrictions on the location of key service providers and higher minimum capitalization requirements.
The Rise of th PIPE Market
COMPANION TO PRIVATE EQUITY, Douglas J. Cumming, ed., Wiley, 2009
The article provides an overview of the emerging PIPE market and existing academic research in this area. I start with an introduction of the PIPE market, such as the definition of PIPE, security structure, and commonly used contract terms. Then I review existing papers examining the cost of PIPEs, returns to PIPE investors, and the role of placement agents in the offering. I also discuss recent SEC enforcement on hedge funds who involved in some PIPE transactions. Finally, I analyze how the current financial crisis has impacted the PIPE market and where this market is heading for.
Fund Size, Limited Attention, and Valuation of Venture Capital Backed Firms
Co-authored with Douglas Cumming
This paper examines the effect of fund size on investee firm valuations in the venture capital market. We show a convex relationship between fund size and firm valuations. We further document firm valuations are positively correlated to measures of limited attention such as fund size per partner and excess fund size per partner. In addition, we show ventures offered higher valuations do not reward their investors with higher exit returns. Our findings hold across a wide range of robustness checks, including but not limited to sample selection and correction for unobserved company-level value drivers. Our findings support the notion that there is diseconomy of scale in the venture capital industry, which is partially due to the constraints from the quality and quantity of human capital when fund size grows.
Hedge Fund Regulation and Misreported Returns
Co-authored with Douglas Cumming
This paper introduces a cross-country law and finance analysis of the misreporting of returns in the hedge fund industry. We find strong evidence that differences in hedge fund regulation significantly affects the propensity of fund managers to misreport monthly returns. Returns are less likely to be misreported among jurisdictions that permit distributions via investment managers, which reflects active external monitoring of reported returns. By contrast, monthly returns are more likely to be misreported among jurisdictions which permit distribution channels via wrappers, banks and private placements, as well as among jurisdictions which have higher minimum capitalization requirements, and jurisdictions that restrict the location of key service providers. Further, the data indicate fund managers that operate more than one fund are more likely to misreport returns. The findings are robust to selection effects and various other robustness checks. We show misreporting significantly affects capital allocation, and calculate the wealth transfer effects of misreporting and relate this wealth transfer to differences in hedge fund regulation.
Why Do Entrepreneurs Switch Venture Capitalists?
Co-authored with Douglas Cumming
We examine the dynamics of the positive sorting in the venture capital (VC) industry by analyzing how the relationship between VCs and entrepreneurial firms evolves as new information regarding the potential of the company is learned. We empirically show that higher-quality companies previously associated with less reputable VCs are more likely to switch to more reputable ones and obtain higher pre-money valuation but smaller investment size in follow-on rounds. On the contrary, lower-quality companies are more likely to switch to less reputable VCs while none of the existing VCs continue investing in them. This group of companies obtain larger investment size but lower pre-money valuation in follow-on rounds. Furthermore, on average, it takes more time for switchers to obtain follow-on financing than non-switchers, which is most significant for those low-quality switchers.
Venture Capital Ownership Type, Investment Criteria, and Venture Performance
Co-authored with Hoje Jo and Sul Kassicieh
We investigate the investment behavior and exit performance of VCs that have pursued expansion outside their home locations. Our findings indicate that in the Asian VC markets, foreign VCs have relative advantages over local VCs in terms of size and experience while they are at disadvantage in information collection and monitoring due to distance. When investing alone, foreign VCs are more likely to invest in more information-transparent ventures. Networks with local VCs help alleviate information asymmetry and monitoring problem. Foreign VC investments overall are more likely to succeed. Ventures invested by foreign and local VCs jointly outperform those invested by foreign VCs alone.
Entrepreneurial Optimism and Capital Structure: Evidence from U.S. Small Businesses
Co-authored with Vladimir I. Ivanov
Does entrepreneurial optimism affect the financing decisions of small firms? Using a large sample of U.S. small businesses and an innovative measure of optimism, we find that higher levels of optimism result in significantly higher leverage. This effect is independent of the effects of the traditional non-behavioral models of capital structure. In addition, we find that firms with optimistic entrepreneurs tend to use more short-term debt.
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