Executive Ownership and Control in Newly Public Firms: The Role of Venture Capitalists

We study the implications of CEO equity ownership for incentives and control in a sample of 1,011 newly public firms. Before an initial public offering, equity investments by venture capitalists reduce CEO ownership by about half, from an average of 35 percent to 19 percent. Venture capitalists narrow this difference by granting options, reducing secondary sales, and lowering the dilution by primary shares, but a gap in post-IPO CEO equity ownership remains. The effect of this lower ownership on incentives depends upon the measure employed the dollar sensitivity of CEO pay to firm value is lower in venture firms, but the elasticity is about the same. In addition, we present evidence that lower ownership, combined with concentrated outside holdings, leads to a reduction in the agency costs of managerial control. We conclude that the patterns of ownership in part represent a tradeoff by venture capitalists between the benefits of incentives and the agency costs of control. * We would like to thank Jennifer Carpenter, Julian Franks, Ken French, Michel Habib, Josh Lerner, Richard Ruback, David Scharfstein, Andrei Shleifer, Per Stromberg, René Stulz, Michael Weisbach, David Yermack, two anonymous referees, and seminar participants at the Copenhagen Business School, Harvard Business School, MIT, New York University, the Norwegian School of Management, Ohio State University, Oxford University, the NBER Corporate Finance Workshop, and the London School of Economics Venture Capital conference for helpful comments and suggestions. Greg Bumovich, Amy Burroughs, Eric Cho, Ilseung Cho, Kevin Cox, Bipasha Majumdar, Alex Tsai, Devin Tucker, and especially Gene DeAngelis and Sam Yeung provided excellent research assistance. The Division of Research of the Harvard Business School and the National Science Foundation provided research support.