The Role Of Venture Capital In China Concept Stock Companies: Certification And Monitoring

"China Concepts Stocks" generally refer to shares from companies whose assets or earnings have significant activities in China. These companies choose to list themselves in US and other mature markets. Prior to 2009, these stocks were regarded as the excellent prospects for oversea investors. But in 2010, they began to face severe credibility crisis, which didn’t come to an end until 2013. China concepts stocks have drawn wide concern and we can easily find that venture capital plays an important role in their development. Venture capital, including venture investment and private equity, provides financing to companies in their start-up or growth stage and generally exit though IPO and M&A of the portfolio companies. Venture capitalists have both positive and negative impact on the companies. On one hand, they are concerned about their reputation in the market, so that they bring high-quality companies to the market at a credible price (Certification hypothesis). They also devote considerable time to monitoring portfolio companies’ operation and management, which helps to improve their quality (Monitoring hypothesis). On the other hand, adverse selection problems often occur that best companies do not finance through venture capitalists due to relatively high costs, while the grandstanding hypothesis makes venture capitalists bring immature portfolio companies to market too early. In this paper, we try to find some evidence showing that venture capital plays certification and monitoring role in their association with China concept stocks.In this paper, we examine the China concepts stocks listed in US from 2000 to 2012 as the sample and conduct research from two perspectives, earning management and post-issue performance. We get the issue-year discretionary current accruals using modified Jones model and then build up multiple regression equation to examine the association between venture capital and earnings management. The result is robust to controls for the endogenous choice of venture capital financing and we also conduct robustness test using Beneish model.In terms of post-issue performance, we examine the following two measures: performance-matched return on sales and market-adjusted buy-and-hold abnormal returns. Finally we draw three conclusions listed as below:1. Compared with non-VC-backed companies, VC-backed Chinese companies have lower level of discretionary current accruals in issue year. Venture Capital can help mitigate earning management;2. VC-backed Chinese companies generally have higher three-year post-issue performance-matched return on sales than non-VC-backed Chinese companies;3. VC-backed Chinese companies have higher three-year post-issue market-adjusted buy-and-hold abnormal returns than non-VC-backed Chinese companies.Based on the above analysis and conclusions, we can safely say that venture capital plays a certification/monitoring role in its investment in US-listed Chinese companies.The conclusion provides some guidance and reference significance to companies which make financing decision, investors who make investing decision and the development of venture capital market as a whole. In the meantime, few studies have been focused on the association between venture capital and US-listed Chinese companies. We also hope this paper can open the subject for discussion and further research.