Are Founder Directors Detrimental to New Ventures at Initial Public Offering?

Abstract

New ventures often form a formal board of directors for the first time at the initial public offering (IPO). The tumult of external changes places a premium on rapid decision making within a resource-constrained venture. According to the social psychological theory, group consensus and decision alternatives serve as two key drivers for making rapid decisions. Therefore, based on signaling theory, the valuation from investors at the IPO depends on the observable signals that can imply the group consensus and decision alternatives in a board. We argue and test the hypothesis that, when group consensus and decision alternative signals are jointly considered, the relationship between the ratio of founders on the board and the IPO price premium will have an inversed U shape. In addition, we analyze how three contextual factors (original chief executive officer [CEO], founders’ ownership, and venture capitalist [VC] on the board) can influence their signal consistency with founder directors on group consensus and decision alternatives, which ultimately changes the pattern of the inverted U shape. Based on a unique sample of 274 Chinese new venture IPOs over the period from 2004 to 2009, our results show that if the firm is managed by a nonoriginal CEO, the relationship between the founder–board ratio and the IPO price premium is an inverse U shape. Furthermore, if a VC sits on the board, the presence of founder directors has a linear positive effect on IPO premium; otherwise, the inverse U-shaped relationship still holds.