Venture Capital,Corporate Control And Corporate Performance

In this article we analyze the influence of venture capital on corporate control and corporate performance.Many research shows that venture capital has value-adding effect and certification effect and also shows that venture capital backed enterprises perform better than non-venture-capital-backed enterprises,both from the operating performance side and the long-run stock return side.However,most of the researches use data from developed markets and only a few uses data from China.China's Chinext was founded in 2009.There were 355 companies listed by end of 2012,among which 206 companies were backed by venture capital.The percentage is as high as 58%.There are enough samples for analysis of the influence of venture capital.First,this article tries to analyze the influence of venture capital on corporate operating performance and long-run stock return.Because the 2014 yearly reports are not published yet,the sample only includes the 281 companies which have operating performance data for at least two years after IPO.For these companies,we match the venture-backed and non-venture-capital-backed companies based on industry and total assets.We use four rates to identify operating performance.They are return on assets,return on equity,return on sales and the percentage of net operating cashflow divided by total assets.The mutli-factor regression shows that venture capital has positive influence on all four rates from the year venture capital injected capital to two years later but not all of the rates are statistically significant.Since the value-adding service and the injection of capital need time to have effects,it is hard to find any significant change in the year the capital is injected.In the first and second year after the venture capital becomes shareholder,venture capital has statically significant effect on return on sales.After comparing the venture-backed and non-venture-backed samples,next we analyze the operating performance change after the capital is injected.In the 281 companies,there are 159 venture-backed companies.The operating performance of the 159 companies is divided to two periods,i.e.before venture capital entry and after venture capital entry.The panel data has six years of data which is three years before venture capital entry,venture capital entry year and two years after venture capital entry.Every year we have 159 samples.The Hausman test shows that a fixed effect model is more suitable.The result shows that venture capital entry has statically significant positive influence on return on assets,return on sales and net operating cashflow divided by total assets.It states that venture capital entry improves the operating performance.However,venture capital has negative influence on return on equity.Possible explanation is that since venture capital is share purchase,the capital injection increases the net equity a lot which makes the return on equity decrease correspondingly.By comparison of venture-backed and non-venture-backed samples,and comparison of operating performances before venture capital entry and after venture capital entry,we find that venture capital has positive effects on corporate operating performance.We use the transaction data from 2009-2014 of Chinext companies to analyze the three year long-run return on IPOs.Event study analysis is used here.Because there are two methods to calculate the stock abnormal return and there are arguments upon which method to use,we use both methods to calculate the abnormal return.The two methods are cumulative abnormal return(hereafter abbreviated to "CAR")and buy and hold abnormal return(hereafter abbreviated to "CHAR").The market base is the Chinext market index.To avoided the possible endorgenity caused by venture capital selection,we use propensity score matching to match the venture-backed companies with non-venture-backed companies based on basic company charactristics.The daily CAR and CHAR shows that there is IPO long-run discount in the two years after IPO but the discount disappears from the third year.The multi factor analysis shows that the IPO return,age of the chairman of the board,and venture capital has statistically significant negative effect on CAR.Whether the company is registered in Beijing,Shanghai,Guangzhou and Shenzhen has significantly positive effect on CAR.Why venture-backed companies do not outperform non-venture-backed companies on the long-run IPO stock return?Possible explanation is that normally the venture capital committed a one year lockup periods.After the lockup periods expire,normally the venture capital will sell the stocks and no longer involve in the corporate management.On the one side,venture capital do not provide valued-adding service any more;on the other side,the selling increase the supply of invested companies' stocks and lower the stock price,which make the relative stock return lower than non-venture backed companies.In order to avoid moral hazard and inverse selection,venture capital always signs different clauses to limit entrepreneurs' control rights on the company.Just like other contracts,investment agreements are not complete contracts.To solve this problem,ways to deal with uncertain circumstances are confirmed in the investment agreements.The clauses normally include management involvement,share repurchases by entrepreneurs,value adjustment,anti-dilution and non-competition.We interviewed six venture capital companies to understand the usage of the clauses in details and found that these clauses are frequently used in practice.Renhe Commercial Holdings Company Limited is a real estate developer registered in Harbin,capital of Helongjiang,China and was listed in the US NASDAQ in 2008.In its prospectus,we can clearly see the clauses signed between entrepreneur and venture capital.It demonstrates typical interest protection by the venture capital.Since the entrepreneur cannot meet the milestones set in the investment agreement,the entrepreneur has to transfer more shares to venture capital.Next,we use the data from Chinext to analyze the board attendance,value adjustment,staged investment and syndicated investment by the venture capital.By consulting the prospectus,we find that there are 12 companies announced the existence of value-adjustment clause.The data shows that companies adopting value adjustment clause has higher intention to use other binding clauses.Among the 12 companies,67%is invested by syndicated venture capital while average percentage of syndicated investment of other venture capital-backed companies is just 49%.92%of the 12 companies assigned board director while the average rate is 71%for other venture capital-backed companies.10 of the 12 companies are supported by foreign and non-government venture capital,which shows that foreign and non-government venture capital tend to use more of the value adjustment clause.Further analysis on syndicated investment shows that 63%of the 206 venture capital-backed companies have more than one venture capital investment.If we confine the syndicated to having more than one venture capital in one round financing,the percentage is 51%,more than half of the total.It seems that venture capital has strong intention to syndicate,which is in accordance with the interview result.Next,we use the 159 venture capital-backed companies which has two years operating performance data to do multi factor regression analysis.The result shows that staged investment,value adjustment clause has positive influence on return on assets,return on sales and net operating cashflow divided by total assets,but the result is not statistically significant.We find that when venture capital invests in early stage of business,the positive effect on company operating performance is statistically significant.We also find that the higher board seat percentage of venture capital,the better the operating performance.However,syndicated investment has significant negative effect on operating performance.Possible explanation is that the more venture capital involved,the more diversified the control rights."Free-ride" problem lowered the value adding and monitoring service by the venture capital.Foreign venture capital has significantly positive effect on operating performance.One of possible the reasons is that they are more experienced than local venture capital.Lastly we use cases of Tai Zi Milk and Leishi Lighting to show the effect of control rights fight on the companies' operating performance.We can see that China's entrepreneurs are very caution about company control rights.In the extreme circumstance,abnormal methods were used to fight venture capital.For the venture capital which relies on contracts and litigation,it is hard for them to get the final success and maintain the normal operation of the companies.There are few listed companies which are controlled by venture capital.However,Jiangxi BoYa is one of them.By comparing it with Beijing LiDeMan,we find that there is no significant difference between them.To demonstrate the litigation protection of the investment clauses,we use the "HaiFu Investment Case" to finish this article.Though this case lasts for three years,finally venture capital won the case.It shows that though the process is very difficult,China's legal system effectively protects the contact rights.