This paper presents evidence using Japanese data that shows that the principal-agent problem between underwriter and issuing firms is the cause of the underpricing of initial public offerings. We find that the initial return is lower when the venture capital is a subsidiary of the lead underwriter and directly invested into the issuing firm rather than via a limited partnership fund. We also find that the initial return is larger when one of the top three security firms is the underwriter. This means that underpricing is more serious when the bargaining power of the underwriter is large. Together, these findings support the hypothesis that an equity investment in issuing firms by the underwriter improves the alignment between the underwriter and the issuing firm, and thus helps to increase the offer price. The principal-agent problem between the underwriter and issuers is one of the reasons for the underpricing.