Initial public offering valuation and prior shared experience in the boardroom of threshold ventures: A study of industry effects

• Published date: 01 September 2019
• Author: Bárbara Larrañeta,Mike Wright,Leticia Pérez‐Calero
• DOI: http://doi.org/10.1111/corg.12281
• Date: 01 September 2019

ORIGINAL ARTICLE

Initial public offering valuation and prior shared experience

in the boardroom of threshold ventures: A study of

industry effects

Leticia Pérez‐Calero

1

|Bárbara Larrañeta

1

|Mike Wright

2

1

Department of Management and Marketing,

Universidad Pablo de Olavide, Seville, Spain

2

Business School, Imperial College London,

South Kensington Campus, London, UK

Correspondence

Leticia Pérez‐Calero, assistant professor,

Department of Management and Marketing,

Universidad Pablo de Olavide, ES‐41013

Seville, Spain.

Email: lcalero@upo.es

Funding information

European Fund for Regional Development,

Grant/Award Number: ECO2015‐69301‐R;

The Program for Advanced Research of the

Spanish Ministry of Economy and

Competitiveness

Abstract

Research question/issue: We explore the following question: How do initial public

offering (IPO) investors value the existence of prior shared experience (PSE) between

the CEO and the board of threshold ventures?

Research findings/insights: Building on the resource provision role of the board,

signaling, and the dynamics of decision making within teams literatures, our results

show that extensive PSE between the CEO and the board is detrimental to IPO

valuation because it augments the perceived risk of overconfidence and myopic deci-

sions sending negative signals to investors. Yet, the industry diversity of that PSE and

the level of industry ambiguity mitigate such negative signaling effects.

Theoretical/academic implications: We make three main contributions to the liter-

ature. First, we make a specific contribution by advancing that extensive PSE between

the CEO and the board is detrimental for IPO value, unless it is mitigated by the diver-

sity of such PSEs across different industries. Our results therefore highlight bound-

aries within which previously accepted findings about the positive relationship

between PSE and new venture performance do not hold. Second, we enrich our

understanding of the relationship between board design and industry conditions by

showing that investors perceive differently the extensiveness of PSE between the

CEO and the board depending on the degree of industry ambiguity. Overall, we move

beyond prior research on signaling, which has tended to focus on primary intended

and costly signals, exploring signals with potential negative effects at IPO.

Practitioner/Policy Implications: Our research has practical implications for ambi-

tious entrepreneurial ventures trying to achieve high growth by going public in their

early stages of development. Board compositions may commonly be transformed

ahead of IPOs to send a signal to the potential investors about their effectiveness

in meeting the strategic challenges of being in the public arena. Our findings suggest

that entrepreneurs, pre‐IPO investors, and their advisors may need to adopt a fine‐

grained approach to constructing effective boards at an early stage.

KEYWORDS

Corporate Governance, Board of Directors, Entrepreneurial Ventures, Industry Ambiguity, Initial

Public Offering, Prior Shared Experience

Received: 21 March 2018 Revised: 27 March 2019 Accepted: 28 March 2019

DOI: 10.1111/corg.12281

322 © 2019 John Wiley & Sons Ltd Corp Govern Int Rev. 2019;27:322–340.wileyonlinelibrary.com/journal/corg

1|INTRODUCTION

Entrepreneurial threshold ventures transitioning to public listing face

the challenge of designing boards that minimize the uncertainty sur-

rounding the initial public offering (IPO) process (Shekhar & Stapledon,

2007). Prior experiences, abilities, and knowledge of the board are

appreciated by potential investors as a powerful signaling mechanism

indicating that the board has the resources to help the venture CEO

to make effective decisions to develop new strategies in a public mar-

ket (Arthurs, Hoskisson, Busenitz, & Johnson, 2008). To attract board

members, these entrepreneurial ventures, in their early years of exis-

tence, often rely on connections and networks of their top managers,

especially the CEO, given their limited organizational slack and legiti-

macy (Chahine & Goergen, 2013, 2014). In so doing, CEOs can count

on colleagues as board members with whom they have prior shared

experiences (PSEs) (Beckman, 2006; Zheng, Devaughn, & Zellmer‐

Bruhn, 2016).

Studies of the influence of PSE of founders before the launch of

the venture on new venture performance initially assumed it was

always beneficial (Beckman, 2006; Eisenhardt & Schoonhoven,

1990). However, empirical findings have yielded mixed results, leading

researchers to question the specific conditions under which PSE could

be beneficial or detrimental (Zheng et al., 2016). This literature has

focused on PSE among new venture teams at the stage of creating ini-

tial policies and procedures of their company and shaping the culture

of the organization but ignored the particular context of entrepreneur-

ial ventures transitioning to listing status (Beckman, 2006; Zheng,

2012). This is an important omission because an IPO is a transforma-

tional event that significantly changes the dominant challenges facing

the firm (Judge et al., 2015; Li, 2008), requiring new skill sets, addi-

tional resources, and changes to business strategy for making effective

decisions (Filatotchev & Bishop, 2002; Wang & Song, 2016). Although

investors may observe PSE as a signal of important decision dynamics

in the boardroom, currently, we lack understanding of the valuation

placed by IPO investors on the existence of PSE between the CEO

and the board.

We suggest that the shared cognition and mental schema among

the CEO and board members leading to group consensus, crucial in

early venture stages (Wezel, Cattani, & Pennings, 2006), may promote

overconfidence and myopic decisions about new strategies and chal-

lenges required at IPO (Beckman, 2006). This may send a negative sig-

nal to investors that the board may lack the ability to assist the CEO in

managing the complexity of a new context of venture growth follow-

ing the IPO (Acharya & Pollock, 2013; Bertoni, Meoli, & Vismara,

2014). However, a board with a diversity of PSEs across different

industries may reduce the signs of myopic decisions (Beckman,

2006; Chung et al., 2015), mitigating investors' concerns about the

existence of PSE between the CEO and the board. Further, the level

of industry ambiguity may affect investors' perceptions about the

requirements for effective decision making (Filatotchev & Bishop,

2002; Park & Patel, 2015) and thereby perceptions about the exis-

tence of PSE. There is consistent evidence that investors particularly

focus on board resources (prior specific experience on the same

industry/firm or in different industries/firms) and industry dynamics

in making their investment choices (Acharya & Pollock, 2013; Chahine,

Filatotchev, & Zahra, 2011; Filatotchev & Bishop, 2002; Filatotchev,

Chahine, Wright, & Arberk, 2005; Sundaramurthy, Pukthuanthong, &

Kor, 2014). Accordingly, drawing on the resource provision role of

the board, signaling, and dynamics of decision making within teams' lit-

eratures, we explore the following research questions: (a) How do IPO

investors value the existence of PSE between the CEO and the board

of threshold ventures? How does (b) the diversity of industry contexts

of such shared experience and (c) the level of industry ambiguity mod-

erate this relationship?

We explore these questions using a database of 124 entrepreneur-

ial ventures from multiple service industries entering the Alternative

Investment Market (AIM) of the London Stock Exchange in the first

2 years after their registration, an especially relevant setting for

answering our research questions. Services have several characteristics

that create uncertainty about the potential value of the venture

(Galvão, de Carvalho, de Oliveira, & de Medeiros, 2018; Kelley,

Donnelly, & Skinner, 1990; Roy, Paul, Quazi, & Nguyen, 2018; Santos,

2002). This difficulty in demonstrating service superiority together with

the new venture's lack of strong financial track record drive investors to

find less visible and even unintended signals of the unobservable qual-

ity of the venture (Daily, Certo, & Dalton, 2005; Higgins & Gulati, 2006)

such as the existence of PSE in the boardroom. These become critical

signals for the market about the new venture going public.

Entrepreneurial ventures may not directly disclose information

about the existence of PSE between the CEO and board. However,

attentive (institutional) investors may obtain such evidence when

actively gathering and rigorously analyzing information about the

board resource provision role (Gulati & Higgins, 2003; Higgins &

Gulati, 2006; Janney & Folta, 2006) by going beyond the information

listed about previous employers and questioning during roadshows

and presentations in investor clubs (Daily et al., 2005; Schiemann,

Richter, & Günther, 2015). This may be particularly the case in alterna-

tive investment markets because firms are not obliged to file a

prospectus but just an admission letter for an exclusive target of insti-

tutional investors.

Our study makes three main contributions to the literature. First,

we make a specific contribution by arguing and showing that exten-

sive PSE between the CEO and the board is detrimental for IPO value.

This is because it augments the risk of overconfidence and myopic

decision making, sending negative signals to the market, unless it is

mitigated by the diversity of such PSEs across different industries.

Our results therefore highlight boundaries within which previously

accepted findings about the positive relationship between PSE and

new venture performance do not hold. Second, we make a specific

contribution to understanding the relationship between board design

and industry conditions by showing that investors perceive differently

the extent of PSE between the CEO and the board depending on the

degree of industry ambiguity. Overall, we move beyond prior research

on signaling, which has tended to focus on the deliberate communica-

tion of positive information (i.e., intended and costly signals), exploring

signals with potential negative effects at IPO.

PÉREZ‐CALERO ET AL.323