We use a database of recent high tech IPOs to estimate opportunity cost of capital for venture capital investors and entrepreneurs. Entrepreneurs face the risk-return tradeoff of the CAPM as the opportunity cost of holding a portfolio that necessarily is underdiversified. For early stage firms, we estimate the effects of underdiversification, industry, and financial maturity on opportunity cost. Assuming a one-year holding period, the entrepreneur's opportunity cost generally is two to four times as high as that of a well-diversified investor. With a 4.0% risk-free rate and 6.0% market risk premium, for the sample average, we estimate the cost of capital of a well-diversified investor to be 11.4%, which equates to 16.7% before the management fees and carried interest of a typical venture capital fund. For an entrepreneur with 25% of total wealth invested in the venture, our corresponding estimate of cost of capital is 40.0%.

We document discretionary underpricing and partial adjustment of IPO prices in the public offer tranche of Japan's hybrid auction regime, in which investor information differences are not important, there are no roadshows, preferential allocations are negligible, institutional investing is low, and the public offer tranche cannot fail. The magnitude and variation of underpricing in our sample, which spans relatively hot and cold markets, are similar to those reported for US IPOs. The evidence is most consistent with underpricing arising from an implicit contract to allocate risk related to initial mispricing where, in exchange for guaranteeing a minimum price, the underwriter participates indirectly in upside performance. The results raise important questions about interpretations of IPO underpricing in the US.