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The Cost of Friendship

Author

Listed:
  • 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.

Suggested Citation

  • Paul Gompers & Vladimir Mukharlyamov & Yuhai Xuan, 2012. "The Cost of Friendship," NBER Working Papers 18141, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:18141 Note: CF
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    References listed on IDEAS

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    1. 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.
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    3. 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, September.
    4. Sergio Currarini & Matthew O. Jackson & Paolo Pin, 2009. "An Economic Model of Friendship: Homophily, Minorities, and Segregation," Econometrica, Econometric Society, vol. 77(4), pages 1003-1045, July.
    5. 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.
    6. William R. Kerr & William F. Lincoln, 2010. "The Supply Side of Innovation: H-1B Visa Reforms and U.S. Ethnic Invention," Journal of Labor Economics, University of Chicago Press, vol. 28(3), pages 473-508, July.
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    8. 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.
    9. 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, February.
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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 15:47:34

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    Cited by:

    1. Hackl, Franz & Hummer, Michael & Pruckner, Gerald J., 2015. "Old boys’ network in general practitioners’ referral behavior?," Journal of Health Economics, Elsevier, vol. 43(C), pages 56-73.
    2. 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.
    3. Bengtsson, Ola & Hsu, David H., 2015. "Ethnic matching in the U.S. venture capital market," Journal of Business Venturing, Elsevier, vol. 30(2), pages 338-354.
    4. Lee, Hoan Soo, 2017. "Peer networks in venture capital," Journal of Empirical Finance, Elsevier, vol. 41(C), pages 19-30.
    5. Cooney, John W. & Madureira, Leonardo & Singh, Ajai K. & Yang, Ke, 2015. "Social ties and IPO outcomes," Journal of Corporate Finance, Elsevier, vol. 33(C), pages 129-146.
    6. Hochberg, Yael V. & Lindsey, Laura A. & Westerfield, Mark M., 2015. "Resource accumulation through economic ties: Evidence from venture capital," Journal of Financial Economics, Elsevier, vol. 118(2), pages 245-267.

    More about this item

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G3 - Financial Economics - - Corporate Finance and Governance
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior

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