Who Becomes the Winner? Effects of Venture Capital on Firmsâ€™ Innovative Incentives - A Theoretical Investigation
AbstractIt is well established in the empirical literature that venture capital (VC) plays an important role in the promotion of innovation at industry level and the professionalisation of firms at micro-level. Whilst the VC-to-success link has been well explored, the mechanism behind how and why certain venture-backed firms are apparently more successful is an important question that has been largely ignored within the majority of the literature. In this paper, we fill this gap by specifically analysing firms' pre- and post-VC investment decisions. By considering a two period, multi-stage game, we analyse whether VC spurs innovation (i) directly after being granted; (ii) indirectly by incentivising firms to increase initial research efforts to increase their chances of receiving VC funding and its associated benefits; or (iii) a combination of both. Our results show that VC has both direct and indirect effects on firms' innovation decisions regardless of whether the firm is successful in securing VC funding or not. Furthermore, we find that the commonly held assertion that venture capital spurs success is too simplistic: whilst venture capital spurs innovation amongst the lucky, chosen few, it unambiguously suppresses innovation of non-VC-backed firms, a result that has been overlooked in the empirical literature. The issue of `who becomes the winner' in the final product market however is ultimately dependent upon the extent of heterogeneity amongst firms. Further, we show that VC funding, equity stake and value-adding services all have impacts upon firms' incentives to invest in the first stage.
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Bibliographic InfoPaper provided by Department of Economics, University of York in its series Discussion Papers with number 13/33.
Date of creation: Dec 2013
Date of revision:
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Postal: Department of Economics and Related Studies, University of York, York, YO10 5DD, United Kingdom
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Venture capital; innovation; firm heterogeneity; investment and effort; strategic substitutes and complements;
Find related papers by JEL classification:
- G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
- L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
- L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior
- O31 - Economic Development, Technological Change, and Growth - - Technological Change; Research and Development; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-12-29 (All new papers)
- NEP-BEC-2013-12-29 (Business Economics)
- NEP-COM-2013-12-29 (Industrial Competition)
- NEP-CSE-2013-12-29 (Economics of Strategic Management)
- NEP-ENT-2013-12-29 (Entrepreneurship)
- NEP-INO-2013-12-29 (Innovation)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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