December 6, 2013
Josh Lerner of Harvard Business School and Antoinette Schoar of MIT, Organizers

Shai Bernstein, Stanford University; Xavier Giroud, MIT and NBER; and Richard Townsend, Dartmouth College

The Impact of Venture Capital Monitoring: Evidence from a Natural Experiment

Bernstein, Giroud, and Townsend examine whether venture capitalists contribute to the innovation and success of their portfolio companies, or merely select companies that are already poised to innovate and succeed. To do so, the authors exploit exogenous reductions in monitoring costs stemming from the introduction of new airline routes between venture capital firms and their existing portfolio companies. Within an existing relationship, the authors find that reductions in travel time are associated with an increase in the number of patents and number of citations per patent of the portfolio company, as well as an increase in the likelihood of an eventual initial public offering or acquisition. These results are robust when controlling for local shocks that could potentially drive the introduction of the new airline routes. The authors further document that the effect is concentrated on routes that connect lead VCs with portfolio companies, as opposed to other investors. Overall, these results are consistent with the monitoring channel and hence indicate that venture capitalists' physical presence at their portfolio companies is an important determinant of innovation and success.

Michael Ewens, Carnegie Mellon University, and Matt Marx, MIT

Executive Turnover in Venture-backed Entrepreneurial Firms

Myriad studies of public companies have tied CEO replacement to various factors including firm performance. We know much less about the dynamics of executive turnover in smaller, privately held ventures. Ewens and Marx provide the first such large-scale analysis, augmenting VentureSource with hand-coding of arrival and departure dates for tens of thousands of executives at thousands of venture capital (VC)-backed companies. The resulting data include 7,242 executive transitions in 13,298 firms. In contrast to prior work, the authors find that executive turnover is not limited to "professionalization" but is driven specifically by corrective action surrounding poor firm performance as well as taking advantage of "hot" liquidity markets. The importance of these signals in turnover decisions depends on the strength of the VC board and investor composition. These results describe when and how investors exercise the control rights contractually afforded them.

Arthur Korteweg, Stanford University, and Stefan Nagel, University of Michigan and NBER

Risk-Adjusting the Returns to Venture Capital (NBER Working Paper 19347)

Performance evaluation of venture capital (VC) payoffs is challenging because payoffs are infrequent, skewed, realized over endogenously varying time horizons, and cross-sectionally dependent. Korteweg and Nagel show that standard stochastic discount factor (SDF) methods can be adapted to handle these issues. Their approach generalizes the Public Market Equivalent (PME) measure commonly used in the private equity literature. They find that the abnormal returns from both VC funds and VC start-up investments are robust to relaxing the strong distributional assumptions and implicit SDF restrictions from the prior literature; VC start-up investments earn substantial positive abnormal returns, and VC fund abnormal returns are close to zero. The authors further show that the systematic component of start-up company and VC fund payoffs resembles the negatively skewed payoffs from selling index put options, which contrasts with the call option-like positive skewness of the idiosyncratic payoffs. Motivated by this finding, the authors explore an SDF that includes index put option returns. This results in negative abnormal returns to VC funds, while the abnormal returns to start-up investments remain large and positive.

Sridhar Arcot and José Miguel Gaspar, ESSEC Business School; Zsuzsanna Fluck, Michigan State University; and Ulrich Hege, HEC Paris

Fund Managers under Pressure: Rationale and Determinants of Secondary Buyouts

The fastest growing segment of private equity (PE) deals is secondary buyouts (SBOs): sales from one PE fund to another. On a comprehensive sample of 9,575 deals, Arcot, Fluck, Gaspar, and Hege investigate whether SBOs are value-maximizing, or reflect opportunistic behavior. To proxy for adverse incentives, the authors develop buy and sell pressure indexes based on how close PE funds are to the end of their investment period or lifetime, their unused capital, reputation, deal activity, and fundraising frequency. The authors report that funds under pressure engage more in SBOs. Pressured buyers pay higher multiples, use less leverage, and syndicate less, suggesting that their motive is to spend equity. Pressured sellers exit at lower multiples and have shorter holding periods. When pressured counterparties meet, deal multiples depend on differential bargaining power. Moreover, funds that invested under pressure underperform.

Aaron Chatterji, Duke University; Rui de Figueiredo, Jr, UC Berkeley; and Evan Rawley, Columbia University

Learning on the Job? Entrepreneurial Spawning in the Asset Management Industry

Entrepreneurs often have prior experience at incumbent firms. Chatterji, de Figueiredo, and Rawley present a new mechanism by which prior employment can influence transitions into entrepreneurship. They argue that some employees divert effort toward unproductive act"experiment," some employees will spawn into related industry segments as entrepreneurs or employees. Others will remain at the incumbent firm or pursue entrepreneurship in the same industry segment. The authors develop a theoretical model to explicate these propositions, and test them using four datasets from the mutual fund and hedge fund industries. The authors find evidence that individuals who engage in excessive risk taking at mutual funds are more likely to transition into hedge funds. Taken together, the authors' findings suggest that learning on the job through experimentation is an important mechanism for enabling entrepreneurial spawning.

Thomas Noe, Oxford University

Blood and Money: Kin altruism, governance, and inheritance in the family firm

Noe develops a theory of governance and inheritance within family firms based on kin altruism (Hamilton 1964). Family members weigh the payoffs to relatives in proportion to relatedness. The theory shows that family management entails both costs and benefits. The attenuated monitoring incentives associated with kin altruism produce a "policing problem" within family firms. This policing problem results in both increased managerial diversion and increased monitoring costs. Relatedness has conflicting effects on manager–owner compensation negotiations. On the one hand, owners are more willing to concede rents to family managers to increase total value. On the other hand, because family managers internalize the costs to the family from their rejection of owner demands, relatedness lowers managers' reservation compensation level. Lower compensation leads to more diversion and costly monitoring. Firm founders anticipate the costs and benefits of family control when designing their bequests. For typical family trees, kin altruism ensures that founders' preferences are much more closely aligned with value maximization than those of any of their descendants. Thus, founder bequests are designed to weaken closer relatives' bargaining power in posthumous negotiations with more competent distant relatives.

Oriana Bandiera, Robin Burgess, London School of Economics; Narayan Das, BRAC; Selim Gulesci, Bocconi University; Imran Rasul, UCL; and Munshi Sulaiman, BRAC -Africa

Can Basic Entrepreneurship Transform the Economic Lives of the Poor?

The world's poorest people lack capital and skills and toil for others in occupations that others shun. Using a large-scale and long-term randomized control trial in Bangladesh, Bandiera, Burgess, Das, Gulesci, Rasul, and Sulaiman demonstrate that sizable transfers of assets and skills enable the poorest women to shift out of agricultural labor and into running small businesses. This shift, which persists and strengthens after assistance is withdrawn, leads to a 38 percent increase in earnings. Inculcating basic entrepreneurship, where severely disadvantaged women take on occupations which were the preserve of non-poor women, is shown to be a powerful means of transforming the economic lives of the poor.

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