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The Cost of Friendship

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  • Paul Gompers
  • Vladimir Mukharlyamov
  • Yuhai Xuan

Abstract

This paper explores two broad questions on collaboration between individuals. First, we investigate what personal characteristics affect people’s desire to work together. Second, given the influence of these personal characteristics, we analyze whether this attraction enhances or detracts from performance. Addressing these problems in the venture capital syndication setting, we show that venture capitalists exhibit strong detrimental homophily in their co-investment decisions. We find that individual venture capitalists choose to collaborate with other venture capitalists for both ability-based characteristics (e.g., whether both individuals in a dyad obtained a degree from a top university) and affinity-based characteristics (e.g., whether individuals in a pair share the same ethnic background, attended the same school, or worked for the same employer previously). Moreover, frequent collaborators in syndication are those venture capitalists who display a high level of mutual affinity. We find that while collaborating for ability-based characteristics enhances investment performance, collaborating for affinity-based characteristics dramatically reduces the probability of investment success. A variety of tests show that the cost of affinity is not driven by selection into inferior deals; the effect is most likely attributable to poor decision-making by high-affinity syndicates post investment. Taken together, our results suggest that non-ability-based “birds-of-a-feather-flock-together” effects in collaboration can be costly.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18141.

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Date of creation: Jun 2012
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Handle: RePEc:nbr:nberwo:18141

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References

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  1. William Kerr & William Lincoln, 2010. "The Supply Side of Innovation: H-1B Visa Reforms and US Ethnic Invention," William Davidson Institute Working Papers Series wp978, William Davidson Institute at the University of Michigan.
  2. Lauren Cohen & Andrea Frazzini & Christopher Malloy, 2008. "The Small World of Investing: Board Connections and Mutual Fund Returns," Journal of Political Economy, University of Chicago Press, vol. 116(5), pages 951-979, October.
  3. Henry Chen & Paul Gompers & Anna Kovner & Josh Lerner, 2010. "Buy Local? The Geography of Venture Capital," NBER Chapters, in: Cities and Entrepreneurship National Bureau of Economic Research, Inc.
  4. Gompers, Paul & Kovner, Anna & Lerner, Josh & Scharfstein, David, 2010. "Performance persistence in entrepreneurship," Journal of Financial Economics, Elsevier, vol. 96(1), pages 18-32, April.
  5. Yael V. Hochberg & Alexander Ljungqvist & Yang Lu, 2007. "Whom You Know Matters: Venture Capital Networks and Investment Performance," Journal of Finance, American Finance Association, vol. 62(1), pages 251-301, 02.
  6. Sergio Currarini & Paolo Pin & Matthew O. Jackson, 2007. "An Economic Model of Friendship: Homophily, Minorities and Segregation," Working Papers 2007_20, Department of Economics, University of Venice "Ca' Foscari".
  7. Heckman, James J, 1979. "Sample Selection Bias as a Specification Error," Econometrica, Econometric Society, vol. 47(1), pages 153-61, January.
  8. Gompers, Paul A., 1996. "Grandstanding in the venture capital industry," Journal of Financial Economics, Elsevier, vol. 42(1), pages 133-156, September.
  9. James A. Brander & Raphael Amit & Werner Antweiler, 2002. "Venture-Capital Syndication: Improved Venture Selection vs. The Value-Added Hypothesis," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 11(3), pages 423-452, 09.
  10. Xuan Tian, 2011. "The Role of Venture Capital Syndication in Value Creation for Entrepreneurial Firms," Review of Finance, European Finance Association, vol. 16(1), pages 245-283.
  11. Becker, Gary S, 1973. "A Theory of Marriage: Part I," Journal of Political Economy, University of Chicago Press, vol. 81(4), pages 813-46, July-Aug..
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Homophily – not all good
    by Nicholas Gruen in Club Troppo on 2012-07-02 10:47:34
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Cited by:
  1. Humphery-Jenner, Mark & Suchard, Jo-Ann, 2013. "Foreign VCs and venture success: Evidence from China," Journal of Corporate Finance, Elsevier, vol. 21(C), pages 16-35.
  2. Franz Hackl & Michael Hummer & Gerald Pruckner, 2013. "Old Boys’ Network in General Practitioner’s Referral Behavior," Economics working papers 2013-10, Department of Economics, Johannes Kepler University Linz, Austria.
  3. Bengtsson, Ola & Hsu, David H., 2013. "Ethnic Matching in the U.S. Venture Capital Market," Knut Wicksell Working Paper Series 2013/8, Knut Wicksell Centre for Financial Studies, Lund University.

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