Abstract

While there have been several theories advanced to explain underpricing, more recently there has been an increased focus on the practices of underwriters that can aggravate underpricing. In these examples, researchers use agency theory and information asymmetry theory to explain the occurrence of underpricing. Other researchers have argued that quid pro quo agreements are in place which allows the underwriter to underprice shares. Quid pro quo arguments are based on the understanding that investors, specifically venture capitalists (VCs), accept greater underpricing in order to gain access to “hot IPOs” in the future. In other words, VCs will accept an initial loss on their current investment in exchange for promised access to future wealth. In this paper, we seek to extend the understanding of quid pro quo agreements between underwriters and VCs. We suggest that the VC – underwriter relationship contributes to the establishment of quid pro quo agreements beyond promised access to future wealth and allows for immediate wealth realization in the form of shorter lock up periods. We identify the sources of quid pro quo agreements by considering the timing of increased underpricing on behalf of the underwriter and the establishment of atypical lock up periods on behalf of the VC. More specifically, we hypothesize that there will be greater underpricing and a shorter lockup when the underwriter and the VC have been involved in previous IPOs together. These factors will be impacted by the number of IPOs that the firms have been involved in, as well as the length of time that the relationship has existed.

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