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Who Becomes the Winner? Effects of Venture Capital on Firms’ Innovative Incentives - A Theoretical Investigation

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  • Matthew Beacham
  • Bipasa Datta

Abstract

It 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.

Suggested Citation

  • Matthew Beacham & Bipasa Datta, 2013. "Who Becomes the Winner? Effects of Venture Capital on Firms’ Innovative Incentives - A Theoretical Investigation," Discussion Papers 13/33, Department of Economics, University of York.
  • Handle: RePEc:yor:yorken:13/33
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    References listed on IDEAS

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    1. Michael Peneder, 2009. "The impact of venture capital on innovation behaviour and firm growth," Venture Capital, Taylor & Francis Journals, vol. 12(2), pages 83-107, November.
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    3. Bottazzi, Laura & Da Rin, Marco & Hellmann, Thomas, 2008. "Who are the active investors?: Evidence from venture capital," Journal of Financial Economics, Elsevier, vol. 89(3), pages 488-512, September.
    4. Thomas J. Chemmanur & Karthik Krishnan & Debarshi K. Nandy, 2011. "How Does Venture Capital Financing Improve Efficiency in Private Firms? A Look Beneath the Surface," Review of Financial Studies, Society for Financial Studies, vol. 24(12), pages 4037-4090.
    5. Engel, Dirk & Keilbach, Max, 2007. "Firm-level implications of early stage venture capital investment -- An empirical investigation," Journal of Empirical Finance, Elsevier, vol. 14(2), pages 150-167, March.
    6. Stefano Caselli & Stefano Gatti & Francesco Perrini, 2009. "Are Venture Capitalists a Catalyst for Innovation?," European Financial Management, European Financial Management Association, vol. 15(1), pages 92-111.
    7. Thomas Hellmann & Manju Puri, 2002. "Venture Capital and the Professionalization of Start-Up Firms: Empirical Evidence," Journal of Finance, American Finance Association, vol. 57(1), pages 169-197, February.
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    9. Steven N. Kaplan & Berk A. Sensoy & Per Strömberg, 2009. "Should Investors Bet on the Jockey or the Horse? Evidence from the Evolution of Firms from Early Business Plans to Public Companies," Journal of Finance, American Finance Association, vol. 64(1), pages 75-115, February.
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    Cited by:

    1. Garry A. Gabison, 2015. "Venture Capital Principles in the European ICT Ecosystem: How can they help ICT innovation?," JRC Working Papers JRC98783, Joint Research Centre (Seville site).

    More about this item

    Keywords

    Venture capital; innovation; firm heterogeneity; investment and effort; strategic substitutes and complements;

    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, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives

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