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The Investment Style Drift Puzzle and Risk-Taking in Venture Capital

Author

Listed:
  • Lukas Koenig
  • Hans-Peter Burghof

Abstract

Limited partners allocate capital into venture capital funds with the expectation of a risk-return profile matching the fund’s investment style in terms of startup investment stage, location, and industry. This paper draws a connection between style drifts in these three dimensions and the connected risk-taking attitude of the general partner. By analyzing a sample of 31,521 investments concerning the motivation for style drifts, this paper seeks to answer whether style drifts are deliberate risk shifts or happen out of competitive pressure. The results suggest that venture capitalists increase risk when they have strong past performance and public markets are bullish to make the most of the balance of compensation and employment incentives. This balancing most likely constitutes an agency conflict between limited partners and general partners. Further, results show that riskier style drifts have a negative impact on investment performance even after controlling for performance persistence and endogeneity. Finally, the findings show that aggregate style drift has a negative effect on a fund’s performance measured as its exit rate.

Suggested Citation

  • Lukas Koenig & Hans-Peter Burghof, 2022. "The Investment Style Drift Puzzle and Risk-Taking in Venture Capital," Review of Corporate Finance, now publishers, vol. 2(3), pages 527-585, December.
    • Handle: RePEc:now:jnlrcf:114.00000023
    DOI: 10.1561/114.00000023
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    Citations

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    Cited by:

    1. Douglas Cumming & Pedro Monteiro, 2023. "Sovereign wealth fund investment in venture capital, private equity, and real asset funds," Journal of International Business Policy, Palgrave Macmillan, vol. 6(3), pages 330-355, September.
    2. Giang Nguyen & My Nguyen & Anh Viet Pham & Man Duy Marty Pham, 2023. "Navigating investment decisions with social connectedness : Implications for venture capital," Post-Print hal-04325756, HAL.
    3. Cumming, Douglas J. & Nguyen, Giang & Nguyen, My, 2022. "Product market competition, venture capital, and the success of entrepreneurial firms," Journal of Banking & Finance, Elsevier, vol. 144(C).
    4. Douglas Cumming & Satish Kumar & Weng Marc Lim & Nitesh Pandey, 2023. "Mapping the venture capital and private equity research: a bibliometric review and future research agenda," Small Business Economics, Springer, vol. 61(1), pages 173-221, June.
    5. Basnet, Anup & Blomkvist, Magnus & Cumming, Douglas J., 2022. "Premature listing and post-IPO venture capital refinancing," Economics Letters, Elsevier, vol. 216(C).
    6. Zhao, Jing & Cao, June & Huang, Jingchang, 2023. "CEO/board medical background and stock returns during the COVID-19 pandemic," Economic Modelling, Elsevier, vol. 127(C).
    7. Nguyen, Giang & Nguyen, My & Pham, Anh Viet & Pham, Man Duy (Marty), 2023. "Navigating investment decisions with social connectedness: Implications for venture capital," Journal of Banking & Finance, Elsevier, vol. 155(C).

    More about this item

    Keywords

    Investment style; style drifts; agency conflict; risk; venture capital; entrepreneurial finance;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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