Founders, Private Equity Investors, and Underpricing in Entrepreneurial IPOs

One of the most important events in the life of an entrepreneurial firm is when it undergoes an initial public offering (IPO). Combining signaling theory with research on the role of information asymmetry in pricing of IPOs this study examines the performance outcomes of two distinct types of agency conflicts at the time of the IPO: adverse selection and moral hazard. Empirical results show a curvilinear (U-shaped) relationship between founders' retained equity and underpricing. This suggests that founders' retained ownership in an entrepreneurial IPO limits adverse selection problems and the associated IPO underpricing; however, at some point entrepreneurs' investment and risk become so great that entrepreneurs may no longer act rationally and moral hazard increases. Empirical findings also indicate that the retained ownership of business angels has a stronger mitigating effect on adverse selection and moral hazard problems than do venture capitalist investors.