Venture Capital Financing and the Informativeness of Earnings

Abstract

Are there long-term costs to obtaining venture capital financing? We explore the hypothesis that venture capital backed firms do not efficiently transform to the corporate structure of public firms and have difficulties publicly communicating with arm's length investors. Our results are three fold. First, we find that, on average, reported accounting earnings are less informative for venture capital backed firms.Second, the informativeness of reported earnings is a decreasing function of venture capitalists' ownership of firm equity and a decreasing function of venture capitalists' board representation. Third, stock prices of venture capital backed firms reflect future earnings to a lesser extent relative to non-venture capital backed firms. Our findings support the hypothesis that venture capitalists manage the flow of public information to capital markets and preserve short term interests arising from specific investment and ownership horizons. This evidence suggests that the benefits of receiving venture capital financing are not without costs. We explore the hypothesis that venture capital backed firms do not efficiently transform to the corporate structure of public firms and have difficulties publicly communicating with arm's length investors. Our results are three fold. First, we find that, on average, reported accounting earnings are less informative for venture capital backed firms.Second, the informativeness of reported earnings is a decreasing function of venture capitalists' ownership of firm equity and a decreasing function of venture capitalists' board representation. Third, stock prices of venture capital backed firms reflect future earnings to a lesser extent relative to non-venture capital backed firms. Our findings support the hypothesis that venture capitalists manage the flow of public information to capital markets and preserve short term interests arising from specific investment and ownership horizons. This evidence suggests that the benefits of receiving venture capital financing are not without costs.JEL Classification: M41, G14, G32

Board of Directors Diversity, Public Ownership, and Earnings Quality

“…(2) Have a complete annual report for the 2015-2019 period; (3) The company did not experience delisting in the research period; (4) The company discloses financial statements in rupiah currency; (5) Companies that have complete data required for research.…”

“…Share ownership by the public reflects the level of ownership of the company by the public. Based on research, [8] and [5] stated that public ownership allows companies to increase public trust in public ownership so that other parties who want to provide loans to companies feel secure. The more the public invests in the company, it means the company has a good reputation.…”

Monitoring or Moral Hazard? Evidence from Real Activities Manipulation by Venture-Backed Companies*

“…Consistent with the VC moral hazard hypothesis, Cohen and Langberg (2006) Lee and Masulis (2008) examine the relationship between venture backing and abnormal accruals and find no relationship exists between VC presence and discretionary accruals for IPO companies after controlling for VC selection endogeneity. 15 2.5 Real Activities Manipulation Healy and Wahlen (1999, 368) note that -earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports either to mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers.‖ Prior literature also discusses the possibility that earnings management occurs not only via accounting estimates and methods but also through operational decisions (Fudenberg and Tirole 1995;Healy and Wahlen 1999;Dechow and Skinner 2000).…”

“…Some studies attribute better financial reporting 5 quality to their monitoring role in the portfolio companies (Hochberg 2003;Morsfield and Tan 2006;Agrawal and Cooper 2008;Wongsunwai 2008). Other studies report evidence that VCs' presence in the portfolio companies impairs financial reporting quality (Darrough and Rangan 2005;Cohen and Langberg 2006;Ertimur, Sletten, and Sunder 2007;Lee and Masulis 2008).…”

The Effect of Earning Persistence and Growth Opportunities on Future Earning Response Coefficient with Public Ownership as Moderation

“…This is because the higher the level of ownership by the public, it will force management to be better at conveying company profit information. Luo et al (2006); Cohen and Langberg (2009); Huang and Wright (2015), explained that public ownership provides an opportunity for companies to maximize public trust in public ownership, thereby providing guarantees for loans received from other parties to the company.…”