UNLEASHING INNOVATION
Yifei Mao; Cornell University
Xuan Tian; Indiana University
Xiaoyun Yu; Indiana University
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 short-termist incentives can be cultivated even in a private equity market populated with long-term,sophisticated investors.
Keywords: Innovation, Stage financing, Venture capital, Short-termism
JEL classification: G24, O31, G34