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Unleashing Innovation

Author
Mao, Yifei; Tian, Xuan; Yu, Xiaoyun
Abstract
Using a sample of venture capital (VC)-backed initial public offering (IPO) firms, we study the effect of financial intermediaries’ tight leash on entrepreneurs’ innovation productivity. We find that financial intermediaries’ tight leash impedes innovation: IPO firms are significantly less innovative when VCs interfere with their development more frequently through staging—as measured by a larger number of VC financing rounds. To establish causality, we exploit plausibly exogenous variation in the frequency of direct flights between VC domiciles and IPO firm headquarters that are due to airline restructuring. Our identification tests suggest a negative, causal effect of VC staging on firm innovation. Furthermore, staging is more detrimental to innovation when innovation is more difficult to achieve and when VCs are less experienced with the industry in which their entrepreneurial firms operate. By documenting a previously underrecognized adverse consequence of VC stage financing, our evidence suggests that contract mechanisms are at play so that short-termist incentives can be cultivated even in a private equity market populated with long-term, sophisticated investors.
Date Issued
2014-11-01Subject
innovation; stage financing; venture capital; short-termism
Rights
Required Publisher Statement: Copyright held by the authors.
Type
preprint