Can Venture Capitalists Tame the Wolves? An Analysis of Fraudulent Underwriters, IPO Characteristics, and VC Certification

Abstract

A recent hit movie, The Wolf of Wall Street, highlighted the fraudulent activity of the investment bank Stratton Oakmont. Unfortunately, this was not the only such financial firm convicted of illegal behavior during the 1990s; there were at least 34 Initial Public Offering (IPO) underwriters that were the subject of SEC enforcement during this period. I examine the characteristics of IPOs underwritten by these investment banks, particularly as they compare to other IPOs. I find that IPOs underwritten by sanctioned investment banks (particularly those that were less active in the IPO market) were significantly different with respect to both firm and offer characteristics, including having higher underpricing and worse long-term performance. Further, such IPOs, while less likely to be backed by a venture capitalist, were positively impacted by this third-party relationship, in that underpricing was lower and long-term return was higher; this is likely due, at least in part, to the certification role provided by venture capitalists.