Module 4 reading list

Bernstein, S. et al. (2022) ‘Do Startups Benefit from Their Investors’ Reputation? Evidence from a Randomized Field Experiment’.

We analyze a field experiment conducted on AngelList Talent, a large online search platform for startup jobs. In the experiment, AngelList randomly informed job seekers of whether a startup was funded by a top-tier investor and/or was funded recently. We find that the same startup receives significantly more interest when information about top-tier investors is provided. Information about recent funding has no effect. The effect of top-tier investors is not driven by low-quality candidates and is stronger for earlier-stage startups. The results show that venture capitalists can add value passively, simply by attaching their names to startups.

Bernstein, S., Giroud, X. and Townsend, R.R. (2016) ‘The Impact of Venture Capital Monitoring’, The Journal of Finance, 71(4), pp. 1591–1622.

We show that venture capitalists’ (VCs) on-site involvement with their portfolio companies leads to an increase in both innovation and the likelihood of a successful exit. We rule out selection effects by exploiting an exogenous source of variation in VC involvement: the introduction of new airline routes that reduce VCs’ travel times to their existing portfolio companies. We confirm the importance of this channel by conducting a large-scale survey of VCs, of whom almost 90% indicate that direct flights increase their interaction with their portfolio companies and management, and help them better understand companies’ activities.

Bernstein, S., Korteweg, A. and Laws, K. (2017) ‘Attracting Early-Stage Investors: Evidence from a Randomized Field Experiment’, The Journal of Finance, 72(2), pp. 509–538.

This paper uses a randomized field experiment to identify which start-up characteristics are most important to investors in early-stage firms. The experiment randomizes investors’ information sets of fund-raising start-ups. The average investor responds strongly to information about the founding team, but not to firm traction or existing lead investors. We provide evidence that the team is not merely a signal of quality, and that investing based on team information is a rational strategy. Together, our results indicate that information about human assets is causally important for the funding of early-stage firms and hence for entrepreneurial success.

Bottazzi, L., Da Rin, M. and Hellmann, T. (2008) ‘Who are the active investors?: Evidence from venture capital’, Journal of Financial Economics, 89(3), pp. 488–512.

This paper examines the determinants and consequences of investor activism in venture capital. Using a hand-collected sample of European venture capital deals, it shows the importance of human capital. Venture capital firms with partners that have prior business experience are more active recruiting managers and directors, helping with fundraising, and interacting more frequently with their portfolio companies. Independent venture capital firms are also more active than ‘captive’ (bank-, corporate-, or government-owned) firms. After controlling for endogeneity, investor activism is shown to be positively related to the success of portfolio companies.

Chemmanur, T. J., Krishnan, K., & Nandy, D. K. (2011). How does venture capital financing improve efficiency in private firms? A look beneath the surface. The Review of Financial Studies, 24(12), 4037-4090.

We use the Longitudinal Research Database (LRD) of the U.S. Census Bureau, which covers the entire universe of private and public U.S. manufacturing firms, to study several related questions regarding the efficiency gains generated by venture capital (VC) investment in private firms. […] Our analysis shows that the overall efficiency of VC-backed firms is higher than that of non-VC-backed firms at every point in time. This efficiency advantage of VC-backed firms arises from both screening and monitoring: The efficiency of VC-backed firms prior to receiving financing is higher than that of non-VC-backed firms, and further, the growth in efficiency subsequent to VC financing is greater for such firms.  […] We disentangle the screening and monitoring effects of VC backing using three different methodologies: switching regression with endogenous switching, regression discontinuity analysis, and propensity score matching. We show that while overall efficiency gains generated by VC backing arise primarily from improvements in sales, the efficiency gains of high-reputation VC-backed firms arise also from lower increases in production costs. Finally, we show that VC backing and the associated efficiency gains positively affect the probability of a successful exit.

Denes, M. R., Howell, S. T., Mezzanotti, F., Wang, X., & Xu, T. (2020). Investor tax credits and entrepreneurship: Evidence from US states (No. w27751). National Bureau of Economic Research.

Angel investor tax credits are used globally to spur high-growth entrepreneurship. Exploiting their staggered implementation in 31 U.S. states, we find that they increase angel investment yet have no significant impact on entrepreneurial activity. Two mechanisms explain these results: Crowding out of alternative financing and low sensitivity of professional investors to tax credits. With a large-scale survey and a stylized model, we show that low responsiveness among professional angels may reflect the fat-tailed return distributions that characterize high-growth startups. The results contrast with evidence that direct subsidies to firms have positive effects, raising concerns about promoting entrepreneurship with investor subsidies.

Gompers, Paul A., Will Gornall, Steven N. Kaplan, and Ilya A. Strebulaev. “How do venture capitalists make decisions?.” Journal of Financial Economics 135, no. 1 (2020): 169-190.

We survey 885 institutional venture capitalists (VCs) at 681 firms to learn how they make decisions. Using the framework in Kaplan and Strömberg (2001), we provide detailed information on VCs’ practices in pre-investment screening (sourcing evaluating and selecting investments), in structuring investments, and in post-investment monitoring and advising. In selecting investments, VCs see the management team as somewhat more important than business-related characteristics such as product or technology although there is meaningful cross-sectional variation across company stage and industry. VCs also attribute the ultimate investment success or failure more to the team than to the business. While deal sourcing, deal selection, and post-investment value-added all contribute to value creation, the VCs rate deal selection as the most important of the three

Hellmann, T. and Puri, M. (2002) ‘Venture Capital and the Professionalization of Start-Up Firms: Empirical Evidence’, The Journal of Finance, 57(1), pp. 169–197.

This paper examines the impact venture capital can have on the development of new firms. Using a hand-collected data set on Silicon Valley start-ups, we find that venture capital is related to a variety of professionalization measures, such as human resource policies, the adoption of stock option plans, and the hiring of a marketing VP. Venture-capital-backed companies are also more likely and faster to replace the founder with an outside CEO,both in situations that appear adversarial and those mutually agreed to. The evidence suggests that venture capitalists play roles over and beyond those of traditional financial intermediaries.

Hsu, D. H. (2004). What do entrepreneurs pay for venture capital affiliation?. The journal of finance, 59(4), 1805-1844.

This study empirically evaluates the certification and value-added roles of reputable venture capitalists (VCs). Using a novel sample of entrepreneurial start-ups with multiple financing offers, I analyze financing offers made by competing VCs at the first professional round of start-up funding, holding characteristics of the start-up fixed. Offers made by VCs with a high reputation are three times more likely to be accepted, and high-reputation VCs acquire start-up equity at a 10–14% discount. The evidence suggests that VCs’ “extra-financial” value may be more distinctive than their functionally equivalent financial capital. These extra-financial services can have financial consequences.

Puri, M. and Zarutskie, R. (2012) ‘On the Life Cycle Dynamics of Venture-Capital- and Non-Venture-Capital-Financed Firms’, The Journal of Finance, 67(6), pp. 2247–2293.

We use data over 25 years to understand the life cycle dynamics of VC- and non-VC financed firms. We find successful and failed VC-financed firms achieve larger scale but are not more profitable at exit than matched non-VC-financed firms. Cumulative failure rates of VC-financed firms are lower, with the difference driven largely by lower failure rates in the initial years after receiving VC. Our results are not driven by VCs disguising failures as acquisitions or by certain types of VCs. The performance difference between VC- and non-VC-financed firms narrows in the post-internet bubble years, but does not disappear.

Rin, M.D., Hellmann, T. and Puri, M. (2013) ‘Chapter 8 – A Survey of Venture Capital Research’, in G.M. Constantinides, M. Harris, and R.M. Stulz (eds) Handbook of the Economics of Finance. pp. 573–648.

Survey article

Sørensen, M. (2007). How smart is smart money? A two‐sided matching model of venture capital. The Journal of Finance, 62(6), 2725-2762.

I find that companies funded by more experienced VCs are more likely to go public. This follows both from the direct influence of more experienced VCs and from sorting in the market, which leads experienced VCs to invest in better companies. Sorting creates an endogeneity problem, but a structural model based on a two-sided matching model is able to exploit the characteristics of the other agents in the market to separately identify and estimate influence and sorting. Both effects are found to be significant, with sorting almost twice as important as inf luence for the difference in IPO rates.