Does Foreign Venture Capital Provide More Value‐added Services to Initial Public Offering Companies in China?

• Date: 01 March 2016
• Author: Yin He,Yunhua Tian,Bin Li,Lijun Wang
• Published date: 01 March 2016
• DOI: http://doi.org/10.1111/cwe.12152

90 China & World Economy / 90–106, Vol. 24, No. 2, 2016

©2016 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Does Foreign Venture Capital Provide More

Value-added Services to Initial Public

Offering Companies in China?

Yin He, Bin Li, Yunhua Tian, Lijun Wang*

Abstract

This paper uses all 1404 initial public offerings (IPO) undertaken between 2002 and 2012

in China to analyze whether venture capital (VC) investment, especially foreign VC investment,

brings more or less value-added services to the invested companies during the 3 years

following the IPO. The results show that venture capitalists choose to invest in companies

with higher value potential, and, in turn, the value of the companies increases after the IPO

is undertaken; foreign VC adds more value to companies than domestic venture capital.

However, the profitability of VC-backed and non VC-backed companies after IPO does not

differ significantly. Nevertheless, it is shown that VC plays an active role in China.

Key words: China, foreign venture capital, initial public offering, profitability, value

JEL codes: F21, G24, G32

I. Introduction and Literature

As an institutional innovation in the last century, venture capital (VC) changed our lifestyles

through financing numerous companies in the information technology (IT) industry,

including Yahoo, Apple, Microsoft and Google. In contrast to the situation in developed

regions, VC in China was initiated by the central government as an experiment in the mid-

*Yin He, Associate professor, School of International Trade and Economics, University of International

Business of Economics, Beijing, China. Email: yheuibe@163.com; Bin Li, PhD candidate, School of

International Trade and Economics, University of International Business of Economics, Beijing, China.

Email: lbp426@hotmail.com; Yunhua Tian (corresponding author), School of Economics and Trade,

Guangdong University of Foreign Studies, Guangzhou, China. Email: yunhua_tian@qq.com; Lijun Wang

(corresponding author), Associate professor, Business School, Beijing Technology and Business University,

Email: whig_wanglj@126.com . The authors are grateful for support provided through Beijing Natural

Science Foundation (Grant No. 9122005) and the project of Collaborative Innovation Center for State-

owned Assets Administration of Beijing Technology and Business University (Grant No. GZ20131101).

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Foreign Venture Capital and IPO in China

©2016 Institute of World Economics and Politics, Chinese Academy of Social Sciences

1980s, with only state-owned or collective-owned VC allowed. Approximately 10 years

later, in 1996, domestic private VC was permitted to enter the market. In comparison, foreign

VC (FVC) was not allowed in China until 2002. Although the VC industry was new in China,

it took off due to a series of legal reforms between 2002 and 2005 and the country ’s sustained

rapid economic growth. The annual VC investment in China in 2006 was only 1.5 percent of

the world total, with this percentage rising to 3.9, 5.1, 2.8, 6.1 and 6.3 percent, respectively,

in the following 5 years (Dow Jones, 2014). The total amount invested by venture capitalists

in mainland China rose from US$6.99bn in 2004 to US$69.19bn in 2013 (Zero2IPO Research,

2014). The deepening of market reform and the development of private entrepreneurship

have driven China’s rapid economic growth (Chu and Song, 2015). There is no doubt that

VC and experienced investors have been and will continue to play a significant role in

finance innovation and commercialization of inventions for China (Fu and Mu, 2014).

The most important objective of VC investment is to bring capital and other value-

creating services to start-up companies that have high value potential but are not mature

enough to obtain finance in the public capital market or through bank loans. The VC

investment enables these companies to survive, grow and succeed, and, in turn, helps the

venture capitalist realize high returns through an initial public offering (IPO) or trade sale of

the company. Thus, compared to an ordinary start-up company, VC investment becomes a

“certification” in the market that states higher potential to succeed. With this “certification,”

the company is more easily able to obtain further financing and other resources from the

market. This is one of the important value-added services VC provides (Barry et al., 1990;

Megginson and Weiss, 1991; Lin, 1996). In addition, to reach their goal of success and cash

out, venture capitalists are comprehensively involved in the companies they finance and

are characterized as “active investors.” Besides providing funds, these active investors

usually add value to their invested companies by engaging in monitoring, recruiting

executives and directors, formulating strategies, and helping with further fund-raising

activities. It has been demonstrated theoretically and empirically that venture capitalists

play an important role in funded companies’ general performance and market value (Lerner,

1995; Kortum and Lerner, 2000; Hellmann and Puri, 2002; Kaplan and Str ömberg, 2004; Guo

and Jiang, 2013; Faria and Barbosa, 2014).

However, if the funded company undertakes an IPO, the IPO event becomes a sufficient

signal of the company’s success. In this sense, the “certification” effect of the VC would be

weakened (Ritter and Welch, 2002). In addition, the equity structure of the company would

change drastically after its IPO. This would discourage the “active participation” and

“monitoring” role of VC (Barry et al., 1990; Ritter and Welch, 2002). From these two aspects,

the positive impact of VC on the funded company’s value and performance would be