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Abstract:
Over the past fifteen years, there has been a tremendous boom in the private equity industry. The pool of U.S. private equity funds (partnerships specializing in venture capital, leveraged buyouts, mezzanine investments, build-ups, and distressed debt) has grown from $5 billion in 1980 to about $150 billion in 1997. Private equity's recent growth has outstripped that of almost every class of financial product. While some of this growth was driven by the easing of federal regulations, it also reflects investors' growing appreciation of the effectiveness of the organizational structures and control mechanisms employed by private equity funds.

This document describes a course exploring this industry, "Venture Capital and Private Equity." This course was introduced by the author of this working paper at Harvard Business School in the 1993-1994 academic year. In recent years, two full sections, each of approximately 100 MBAs and other students have signed up for the course, with a significant waiting list. The cases in this course have also been used in a variety of other settings, including an annual executive education course on private equity organized by Paul Gompers and the author at Harvard Business School, and in entrepreneurship and private equity courses at a variety of other major business schools.

Three primary pedagogical objectives motivate the design and structure of the course. First, and most fundamentally, the course seeks to deepen students' understanding of corporate finance. This course differs from some academic programs in entrepreneurship, which emphasize the uniqueness of private equity finance and the limited applicability of academic theory. For instance, one leading entrepreneurship text [Timmons, 1994] states, "there are both stark and subtle differences, both in theory and practice, between entrepreneurial finance as practiced in higher potential ventures and corporate or administrative finance, which usually occurs in larger publicly traded companies. Further, there are important limits to some financial theories as applied to new ventures." By way of contrast, this course emphasizes the relevance of the intellectual frameworks used to analyze corporate finance problems (incomplete contracting theory, agency problems, etc.) for the private equity industry. Wherever possible, the links to other finance courses are emphasized. Thus, one goal is to review and apply the key concepts and tools of corporate finance in an environment that the students perceive as very interesting.

Second, the course seeks to build familiarity with the key institutional features of the private equity industry. Whether discussing fund structures, potential investments, or returns, participants in the private equity industry often describe phenomena in language that is somewhat different from other financial investors. Understanding the key frameworks employed by private equity investors, and relating them to traditional finance practice, is thus an important goal. A related objective is building an appreciation for the gradations inherent in the industry. Students often consider the private equity industry as an undifferentiated whole, without appreciating the very significant differences in the standards and practices that exist between these groups. An appreciation of the many important differences between these groups is important lesson. Much of the fulfillment of this second goal, it is important to note, takes place outside of the classroom. An important component of the course is the final paper. Whether students intend to work for a private equity organization or to accept money from one, careful due diligence is essential. Private equity funds jealously guard their privacy, and distinguishing between top-tier organizations and less reputable concerns is not always easy. The final paper offers an opportunity to become better acquainted with key resources, including trade magazines, legal handbooks, academic articles, and on-line databases. An important resource in completing the project is the VentureOne database of private equity financings, which the firm has generously made available to the class.

Finally, a crucial objective is to build an appreciation of the valuation process in the private equity setting. Valuation issues are often the subject of contentious disputes, whether the context is assessing the relative past returns of several private equity groups, determining the impact of a shift in a buyout fund's fee structure, allocating equity in a start-up to management and one or more private equity groups, or assessing the impact of a "sweetener" of warrants (a grant of warrants in addition to a block of equity) on the price paid per share by private equity investors. Industry practice, reflecting private equity's early state of evolution relative to many other financial sectors, can often appear to the outside observer as sloppy and not standardized. Skill in analyzing value is likely to be an increasingly important competitive skill in the private equity industry. This course consequently introduces a wide array of valuation methodologies. These range from approaches commonly seen in practice (e.g., the use of comparables and the "venture capital" method) to those less frequently employed but likely to be useful nonetheless (the use of Monte Carlo simulations and option pricing techniques). The course emphasizes not only the mechanisms employed, but also how to clearly communicate the strengths and limitations of each approach. These discussions are facilitated by the use of Harvard Business School's electronic infrastructure. For a typical class, a spreadsheet containing the case problems is posted on the School's intranet prior to class, the class discussion includes an analysis of the spreadsheet (with the spreadsheet simultaneously projected on the central screen), and the fully worked analysis is posted on the intranet immediately after class.

The course is organized in four modules. The first module of "Venture Capital and Private Equity" examines how private equity funds are raised and structured. The structure of private equity funds have a profound effect on the behavior of venture and buyout investors. The module seeks not only to understand the features of private equity funds and the actors in the fundraising process, but also to analyze which institutions serve to increase the profits from private equity investments as a whole, and which seem designed mostly to shift profits between the parties.

The second module of the course considers the interactions between private equity investors and the entrepreneurs that they finance. The course approaches these interactions through a two-part framework, first identifying the four critical factors that make it difficult for the types of firms backed by private equity investors to meet their financing needs through traditional mechanisms, and then considering six classes of financial and organizational responses by private equity investors.

The third module of "Venture Capital and Private Equity" examines the process through which private equity investors exit their investments. Successful exits are critical to insuring attractive returns for investors, but private equity investors' behavior around the exiting process can sometimes lead to severe problems for entrepreneurs. We seek to understand which institutional features associated with exiting private equity investments increase the overall amount of profits from private equity investments, and which actions seem to be intended to shift more of the profits to particular parties.

The final module reviews many of the key ideas developed in the course. Rather than considering traditional private equity organizations, however, the two cases examine organizations with very different goals, examining funds established by a large corporation and a non-profit organization. These cases allow us not only to understand these challenging initiatives, but to review the elements that are crucial to the success of traditional private equity organizations.

See also my related papers "Money Chasing Deals?: The Impact of Fund Inflows on Private Equity Valuations", "What Drives Venture Capital Fundraising?", and "Conflict of Interest and Reputation in the Issuance of Public Securities: Evidence from Venture Capital".

Abstract:
Over the past fifteen years, there has been a tremendous boom in the private equity industry. The pool of U.S. private equity funds (partnerships specializing in venture capital, leveraged buyouts, mezzanine investments, build-ups, and distressed debt) has grown from $5 billion in 1980 to nearly $300 billion at the beginning of 2001. This growth was particularly pronounced in the final years of the 20th century.

This document describes a course exploring this industry, "Venture Capital and Private Equity." This course was introduced by the author at Harvard Business School in the 1993-1994 academic year. In recent years, this course has been one of the five largest elective courses at the Harvard Business School. The cases in this course have also been used in a variety of other settings, including an annual executive education course on private equity and in entrepreneurship and private equity courses at a variety of other major business schools.

Three primary pedagogical objectives motivate the design and structure of the course. First, and most fundamentally, the course seeks to deepen students' understanding of corporate finance. This course differs from some academic programs in entrepreneurship, which emphasize the uniqueness of private equity finance and the limited applicability of academic theory. By way of contrast, this course emphasizes the relevance of the intellectual frameworks used to analyze corporate finance problems (incomplete contracting theory, agency problems, etc.) for the private equity industry. Wherever possible, the links to other finance courses are emphasized. Thus, one goal is to review and apply the key concepts and tools of corporate finance in an environment that the students perceive as very interesting.

Second, the course seeks to build familiarity with the key institutional features of the private equity industry. Whether discussing fund structures, potential investments, or returns, participants in the private equity industry often describe phenomena in language that is somewhat different from other financial investors. Understanding the key frameworks employed by private equity investors, and relating them to traditional finance practice, is thus an important goal. Among the critical issues that students gain appreciation is the process of career management in the private equity industry.

Finally, a crucial objective is to build an appreciation of the valuation process in the private equity setting. Valuation issues are often the subject of contentious disputes. Industry practice, reflecting private equity's early state of evolution
relative to many other financial sectors, can often appear to
the outside observer as sloppy and not standardized. Skill in
analyzing value is likely to be an increasingly important
competitive skill in the private equity industry. This course
consequently introduces a wide array of valuation methodologies. These include approaches commonly seen in practice (e.g., the
use of comparables and the "venture capital" method) as well as those less frequently employed but likely to be useful
nonetheless (the use of Monte Carlo simulations and option
pricing techniques). The course emphasizes not only the
mechanisms employed, but also how to clearly communicate the
strengths and limitations of each approach.

Abstract:
We examine the determinants of venture capital fundraising in the U.S. over the past twenty-five years. We study industry aggregate, state-level, and firm-specific fundraising to determine if macroeconomic, regulatory, or performance factors affect venture capital activity. We find that shifts in demand for venture capital appear to have a positive and important impact on commitments to new venture capital funds. Commitments by taxable and tax-exempt investors seem equally sensitive to changes in capital gains tax rates that decreases in capital gains tax rates increase the demand for venture capital as more workers are incented to become entrepreneurs. Aggregate and state level venture fundraising are positively affected by easing of pension investment restrictions as well as industrial and academic R&D expenditures. Fund performance and reputation also lead to greater fundraising by venture organizations.

Abstract:
We examine the determinants of venture capital fundraising in the U.S. over the past twenty-five years. We study industry aggregate, state-level, and firm-specific fundraising to determine if macroeconomic, regulatory, or performance factors affect venture capital activity. We find that shifts in demand for venture capital appear to have a positive and important impact on commitments to new venture capital funds. Commitments by taxable and tax-exempt investors seem equally sensitive to changes in capital gains tax rates, consistent with the notion that decreases in capital gains tax rates increase the demand for venture capital as more workers are incented to become entrepreneurs. Aggregate and state level venture fundraising are positively affected by easing of pension investment restrictions as well as industrial and academic R&D expenditures. Fund performance and reputation also lead to greater fundraising by venture organizations.

Abstract:
This paper examines the positive impact of the inflows of capital into venture funds on the valuations of their investments in firms and two potential explanations for the relationship. Growth in venture capital commitments is shown to increase the valuation of new investments. This effect is robust to (i) the addition of controls for firm characteristics, public market valuations, and various alternative hypotheses, (ii) an examination of first differences, and (iii) the use of inflows into leveraged buyout funds as an instrumental variable. Interaction terms suggest that the impact of venture capital inflows on prices is greatest in states with the most venture capital activity. Changes in valuations do not appear related to the ultimate success of these firms. The findings are consistent with suggestions that competition for a limited number of good investments may be responsible for rising prices.


See also my related papers "Venture Capital and Private Equity: A Course Overview", "What Drives Venture Capital Fundraising?", and "Conflict of Interest and Reputation in the Issuance of Public Securities: Evidence from Venture Capital".

Abstract:
The past year has seen a dramatic decline in venture capital activity. Investment activity and fundraising by venture capital organizations have fallen sharply, and few observers expect a revival anytime soon.

This paper seeks to understand the implications of the recent collapse in venture activity on innovation. It argues that the situation may not be as grim as it initially appears. While there are many reasons for believing that on average venture capital has a powerful impact on innovation, the impact is far from uniform. In particular, during boom periods, the prevalence of over-funding of particular sectors can lead to a sharp decline in terms of the effectiveness of venture funds. While prolonged downturns may eventually lead to good companies going unfunded, many of the dire predictions seem overstated.

I proceed in three parts. First, I consider the cyclical nature of the venture industry. I explore why shifts in opportunities often do not rapidly translate into increase fundraising. I also highlight the tendency for the supply of venture capital, when it does finally adjust to shifts in demand, to react in an excessively dramatic manner. I explore how the structure of the venture funds themselves and the information lags in the venture investment process may lead to this "over-shooting" phenomenon. Similarly, I discuss the determinants of "busts," such as the industry is experiencing today.

I then consider the implications of these shifts on innovation. I review the more general evidence that suggests that venture capitalists have a powerful impact on innovation. I then consider both field-based and statistical evidence that the effects of venture investment on innovation are not uniform. I argue that the impact of these funds on innovation during period of rapid growth, or booms, is attenuated. At the same time, I consider the implications of prolonged troughs, such as the venture industry experienced in the 1970s, and highlight the apparently detrimental consequences of such events.

In the conclusion, I consider some of the implications for public policy. My analysis suggests that, while the rise of venture capital has been an important contributor to technological innovation and economic prosperity, an effective policy agenda going forward will not simply seek to spur much venture financing. I highlight the fact that many of the steps that policymakers have pursued have had the consequence of throwing "gasoline on the fire": i.e., they have exacerbated the cyclical nature of venture funding. Instead, the environment for venture capital investment can be substantially improved by government policies that encourage private investment and address "gaps" in the private funding process, such as industrial segments that have not historically captured the attention of venture financiers. In short, I argue that policymakers have to view efforts to assist young firms within the context of the changing private sector environment.

Financing, Technological Change, Cycles

Abstract:
This paper argues that a large component of success in entrepreneurship and venture capital can be attributed to skill. We show that entrepreneurs with a track record of success are more likely to succeed than first time entrepreneurs and those who have previously failed. Funding by more experienced venture capital firms enhances the chance of success, but only for entrepreneurs without a successful track record. Similarly, more experienced venture capitalists are able to identify and invest in first time entrepreneurs who are more likely to become serial entrepreneurs. Investments by venture capitalists in successful serial entrepreneurs generate higher returns for their venture capital investors. This finding provides further support for the role of skill in both entrepreneurship and venture capital.

new ventures, entrepreneurs

Abstract:
In recent years, university endowments have received much attention for their spectacular returns and innovative investment strategies, but few papers have examined trends in the endowment sector at large. In this paper, we analyze a sample of 1,300 educational endowments between 1992 and 2005. A striking phenomenon emerges of the rich getting richer, a dramatic widening of the size gap between the largest endowments, led by the Ivy League, and the average endowment. Growth in endowment size has been driven largely by high investment returns, which are in turn related to the quality of the student body and the use of alternative assets. Elite endowments seem to benefit not only from economies of scale in investment management, but genuine skill and expertise in choosing the right investments at the right times.

Abstract:
In this paper, we have sought to understand what has been the performance of university endowments, and what drives the observed pattern of performance. Our key observations are as follows: (a) the endowments of elite universities have grown dramatically faster than endowments overall; (b) initial endowment size, size of student population, student SAT scores, and membership in the Ivy Plus group are significantly correlated with endowment growth and endowment returns, but endowment returns for public and private schools are very similar; (c) there is considerable persistence of returns across the endowments, particularly among underperforming schools; and (d) alternative investments appear to play an important part in the success of the highest-return endowments, but this strategy cannot be emulated with ease. We also identify a number of unanswered questions. Three gaps in our understanding seem particularly interesting from an academic perspective, as well as practically relevant for those who run or oversee university endowments and other investment pools: the ways in which endowment offices are organized, and how these choices contribute to their success or failure; the viability of the strategies pursued by endowments going forward; and the challenges of imitation.

asset allocation, investment management, private equity, hedge funds

Abstract:
This paper presents a theory of liquidity where we explicitly model the liquidity of the security as a choice variable, which enables the manager raising the funds to screen for 'deep pocket' investors, i.e. these that have a low likelihood of a liquidity shock. By choosing the degree of illiquidity of the security, the manager can influence the type of investors the firm will attract. The benefit of liquid investors is that they reduce the manager's cost of capital for future fund raising. If inside investors have fewer information asymmetries about the quality of the manager than the outside market, more liquid investors protect the manager from having to return to the outside market, where he would face higher cost of capital due to asymmetric information problems. We test the predictions of our model in the context of the private equity industry. Consistent with the theory, we find that transfer restrictions on investors are less common in later funds organized by the same private equity firm, where information problems are presumably less severe. Contracts involving the close-knit California venture capital community - where information on the relative performance of funds are more readily ascertained - are less likely to employ many of these provisions as well. Also, private equity partnerships whose investment focus is in industries with longer investment cycles display more transfer constraints. For example, funds focusing on the pharmaceutical industry have more constraints, while those specializing in computing and Internet investments have fewer constraints. Finally, we investigate whether the identity of the investors that invest in a private equity fund is related to the transferability of the stakes. We find that transferability constraints are less prevalent when private equity funds have limited partners that are known to have few liquidity shocks, for example endowments, foundations, and other investors with long-term commitments to private equity.

Abstract:
This paper presents a theory of liquidity where we explicitly model the liquidity of the security as a choice variable, which enables the manager raising the funds to screen for "deep pocket" investors, i.e. these that have a low likelihood of a liquidity shock. By choosing the degree of illiquidity of the security, the manager can influence the type of investors the firm will attract. The benefit of liquid investors is that they reduce the manager's cost of capital for future fund raising. If inside investors have fewer information asymmetries about the quality of the manager than the outside market, more liquid investors protect the manager from having to return to the outside market, where he would face higher cost of capital due to asymmetric information problems. We test the predictions of our model in the context of the private equity industry. Consistent with the theory, we find that transfer restrictions on investors are less common in later funds organized by the same private equity firm, where information problems are presumably less severe. Contracts involving the close-knit California venture capital community - where information on the relative performance of funds are more readily ascertained - are less likely to employ many of these provisions as well. Also, private equity partnerships whose investment focus is in industries with longer investment cycles display more transfer constraints. For example, funds focusing on the pharmaceutical industry have more constraints, while those specializing in computing and Internet investments have fewer constraints. Finally, we investigate whether the identity of the investors that invest in a private equity fund is related to the transferability of the stakes. We find that transferability constraints are less prevalent when private equity funds have limited partners that are known to have few liquidity shocks, for example endowments, foundations, and other investors with long-term commitments to private equity.

Abstract:
There has been a recent surge of interest in open source software development, which involves developers at many different locations and organizations sharing code to develop and refine programs. To an economist, the behavior of individual programmers and commercial companies engaged in open source projects is initially startling. This paper makes a preliminary exploration of the economics of open source software. We highlight the extent to which labor economics, especially the literature on "career concerns," can explain many of these projects' features. Aspects of the future of open source development process, however, remain somewhat difficult to predict with "off-the-shelf" economic models.

Abstract:
There has been a recent surge of interest in open source software development, which involves developers at many different locations and organizations sharing code to develop and refine programs. To an economist, the behavior of individual programmers and commercial companies engaged in open source projects is initially startling. This paper makes a preliminary exploration of the economics of open source software. We highlight the extent to which labor economics, especially the literature on career concerns,' can explain many of these projects' features. Aspects of the future of open source development process, however, remain somewhat difficult to predict with off-the-shelf' economic models.

Abstract:
While policymakers often assume venture capital has a profound impact on innovation, that premise has not been evaluated systematically. We address this omission by examining the influence of venture capital on patented inventions in the United States across twenty industries over three decades. We address concerns about causality in several ways, including exploiting a 1979 policy shift that spurred venture capital fundraising. We find that the amount of venture capital activity in an industry significantly increases its rate of patenting. While the ratio of venture capital to R&D has averaged less than 3% in recent years, our estimates suggest that venture capital accounts for about 15% of industrial innovations. We address concerns that these results are an artifact of our use of patent counts by demonstrating similar patterns when other measures of innovation are used in a sample of 530 venture-backed and non-venture-backed firms.

Abstract:
While policymakers often assume venture capital has a profound impact on innovation, that premise has not been evaluated systematically. We address this omission by examining the influence of venture capital on patented inventions in the United States across twenty industries over three decades. We address concerns about causality in several ways, including exploiting a 1979 policy shift that spurred venture capital fundraising. We find that the amount of venture capital activity in an industry significantly increases its rate of patenting. While the ratio of venture capital to R&D has averaged less than 3% in recent years, our estimates suggest that venture capital accounts for about 15% of industrial innovations. We address concerns that these results are an artifact of our use of patent counts by demonstrating similar patterns when other measures of innovation are used in a sample of 530 venture-backed and non-venture-backed firms.

Abstract:
Reverse leveraged buyouts (RLBOs) have received increased public scrutiny but attracted little systematic study. We collect a comprehensive sample of 496 RLBOs between 1980 and 2002 and examine three- and five-year stock performance of these offerings. RLBOs appear to consistently outperform other IPOs and the stock market as a whole, with economically and statistically meaningful positive returns. There is no evidence of a deterioration of returns over time, despite the growth of the buyout market: RLBOs performed strongly in the late 1980s, the mid-1990s, and the 2000s. Large RLBOs that are backed by private equity firms with more capital under management perform better. We also find the so-called quick flips - when private equity firms sell off an investment within a year after acquisition - underperform.

Abstract:
Reverse leveraged buyouts (RLBOs) have received increased public scrutiny but attracted little systematic study. We collect a comprehensive sample of 526 RLBOs between 1981 and 2003 and examine three- and five-year stock performance of these offerings. RLBOs appear to perform as well as or better than other IPOs and the stock market as a whole, depending on the specification. There is evidence of a deterioration of returns over time.

RLBO, IPO, Private Equity, Long-run performance

Abstract:
In this paper we investigate potential conflicts of interest in the issuance of public securities in a setting analogous to a universal bank, i.e., the underwriting of initial public offerings by investment banks that hold equity in a firm through a venture capital subsidiary. We contrast two hypotheses. Under "rational discounting," all market participants fully anticipate the conflict. The "naive investor" hypothesis suggests that investment banks are able to utilize superior information when they underwrite securities. The evidence supports the rational discounting hypothesis. Initial public offerings that are underwritten by affiliated investment banks perform as well or better than issues of firms in which none of the investment banks held a prior equity position. Investors do, however, require a greater discount at the offering to compensate for potential adverse selection. We also provide evidence that investment bank-affiliated venture firms address the potential conflict by investing in and subsequently underwriting less information-sensitive issues. Our evidence provides no support for the prohibitions on universal banking instituted by the Glass-Steagall Act of 1933.

Abstract:
In this paper we investigate potential conflicts of interest in the issuance of public securities in a setting analogous to a universal bank, i.e., the underwriting of initial public offerings by investment banks that hold equity in a firm through a venture capital subsidiary. We contrast two hypotheses. Under "rational discounting," all market participants fully anticipate the conflict. The "naive investor" hypothesis suggests that investment banks are able to utilize superior information when they underwrite securities. The evidence supports the rational discounting hypothesis. Initial public offerings that are underwritten by affiliated investment banks perform as well or better than issues of firms in which none of the investment banks held a prior equity position. Investors do, however, require a greater discount at the offering to compensate for potential adverse selection. We also provide evidence that investment bank-affiliated venture firms address the potential conflict by investing in and subsequently underwriting less information-sensitive issues. Our evidence provides no support for the prohibitions on universal banking instituted by the Glass-Steagall Act of 1933.

Abstract:
This paper reviews our understanding of the growing open source movement. We highlight how many aspects of open source software appear initially puzzling to an economist. As we have acknowledge, our ability to answer confidently many of the issues raised here questions is likely to increase as the open source movement itself grows and evolves. At the same time, it is heartening to us how much of open source activities can be understood within existing economic frameworks, despite the presence of claims to the contrary. The labor and industrial organization literatures provide lenses through which the structure of open source projects, the role of contributors, and the movement's ongoing evolution can be viewed.

Abstract:
This paper reviews our understanding of the growing open source movement. We highlight how many aspects of open source software appear initially puzzling to an economist. As we have acknowledged, our ability to answer confidently many of the issues raised here questions is likely to increase as the open source movement itself grows and evolves. At the same time, it is heartening to us how much of open source activities can be understood within existing economic frameworks, despite the presence of claims to the contrary. The labor and industrial organization literatures provide lenses through which the structure of open source projects, the role of contributors, and the movement's ongoing evolution can be viewed.

intellectual property, software, licensing, innovation

Abstract:
The returns that institutional investors realize from private equity investments differ dramatically across institutions. Using detailed and hitherto unexplored records of fund investors and performance, we document large heterogeneity in the performance of different classes of limited partners. In particular, endowments' annual returns are nearly 14% greater than average. Funds selected by investment advisors and banks lag sharply. These results are robust to controlling for the type and year of the investment, as well as to the use of different specifications. Analyses of reinvestment decisions and young funds suggest that the results are not primarily due to endowments' greater access to established funds. Finally, we examine the differences in the choice of intermediaries across various institutional investors and their relationship to success. We find that LPs that have higher average IRRs also tend to invest in older funds and have a smaller fraction of GPs in their geographic area, and that the performance of university endowments is correlated with measures of the quality and loyalty of the student body.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
The returns that institutional investors realize from private equity investments differ dramatically across institutions. Using detailed and hitherto unexplored records of fund investors and performance, we document large heterogeneity in the performance of different classes of limited partners. In particular, endowments' annual returns are nearly 14% greater than average. Funds selected by investment advisors and banks lag sharply. These results are robust to controlling for the type and year of the investment, as well as to the use of different specifications. Analyses of reinvestment decisions and young funds suggest that the results are not primarily due to endowments' greater access to established funds. Finally, we examine the differences in the choice of intermediaries across various institutional investors and their relationship to success. We find that LPs that have higher average IRRs also tend to invest in older funds and have a smaller fraction of GPs in their geographic area, and that the performance of university endowments is correlated with measures of the quality and loyalty of the student body.

limited partners, LPs, endowments, institutional investors

Abstract:
We explore the impact of the institutional environment on the nature of entrepreneurial activity across Europe. Political, legal, and regulatory variables that have been shown to impact capital market development influence entrepreneurial activity in the emerging markets of Europe, but not in the more mature economies of Europe. Greater fairness and greater protection of property rights increase entry rates, reduce exit rates, and lower average firm size. Additionally, these same factors also associated with increased industrial vintage - a size-weighted measure of age - and reduced skewness in firm-size distributions. The results suggest that capital constraints induced by these institutional factors impact both entry and the ability of firms to transition and grow, particularly in lesser-developed markets.

Entrepreneurship, Institutions, Capital Constraints, Firm Size Distributions, Entry, Exit, Legal Regimes

Abstract:
We explore the impact of the institutional environment on the nature of entrepreneurial activity across Europe. Political, legal, and regulatory variables that have been shown to impact capital market development influence entrepreneurial activity in the emerging markets of Europe, but not in the more mature economies of Europe. Greater fairness and greater protection of property rights increase entry rates, reduce exit rates, and lower average firm size. Additionally, these same factors also associated with increased industrial vintage - a size-weighted measure of age - and reduced skewness in firm-size distributions. The results suggest that capital constraints induced by these institutional factors impact both entry and the ability of firms to transition and grow, particularly in lesser-developed markets.

Abstract:
Financial economists in recent years have closely examined and intensely debated the performance of initial public offerings using data after the formation of NASDAQ. The paper seeks to shed light on this controversy by undertaking a large, out-of-sample study: we examine the performance for up to five years after listing of nearly 3,661 initial public offerings in the United States from 1935 to 1972. The sample displays some evidence of underperformance when event-time buy-and-hold abnormal returns are used. The underperformance disappears, however, when cumulative abnormal returns are utilized. A calendar-time analysis also shows that over the entire sample period - i.e., from 1935 to 1976 - IPOs return as much as the market. Finally, the intercepts in CAPM and Fama-French three-factor regressions are insignificantly different from zero, suggesting no abnormal performance.

Abstract:
Financial economists in recent years have closely examined and intensely debated the performance of initial public offerings using data after the formation of NASDAQ. The paper seeks to shed light on this controversy by undertaking a large, out-of-sample study: we examine the performance for up to five years after listing of nearly 3,661 initial public offerings in the United States from 1935 to 1972. The sample displays some evidence of underperformance when event-time buy-and-hold abnormal returns are used. The underperformance disappears, however, when cumulative abnormal returns are utilized. A calendar-time analysis also shows that over the entire sample period - i.e., from 1935 to 1976 - IPOs return as much as the market. Finally, the intercepts in CAPM and Fama-French three-factor regressions are insignificantly different from zero, suggesting no abnormal performance.

Abstract:
While variations in public securities markets across nations have attracted increasing scrutiny, private financings have received little attention. But in developing nations, the bulk of financings are private ones. This paper analyzes 210 private equity transactions in developing countries. We find that unlike in the U.S., where convertible preferred securities are ubiquitous, in developing nations a much broader array of securities are employed and private equity investors often have fewer contractual protections. The choice of security appears to be driven by the legal and economic circumstances of the nation and the private equity group. Investments in common law nations are structured similar to those in the U.S., being less likely to employ common stock or straight debt, and more likely to use preferred stock with a variety of covenants. By way of contrast, in nations where the rule of law is less established, private equity groups are likely to use common stock and own the majority of the firm's equity if the investment encounters difficulties. Private equity groups based in the U.S. and U.K. rely more on preferred securities but also adapt transactions to local conditions. These contractual differences appear to have real consequences: larger transactions with higher valuations are seen in common law countries. These findings suggest that the structure of a country's legal system affects private contracts and cannot easily be undone by (bi-lateral) private solutions.

Abstract:
While variations in public securities markets across nations have attracted increasing scrutiny, private financings have received little attention. But in developing nations, the bulk of financings are private ones. This paper analyzes 210 private equity transactions in developing countries. We find that unlike in the U.S., where convertible preferred securities are ubiquitous, in developing nations a much broader array of securities are employed and private equity investors often have fewer contractual protections. The choice of security appears to be driven by the legal and economic circumstances of the nation and the private equity group. Investments in common law nations are structured similar to those in the U.S., being less likely to employ common stock or straight debt, and more likely to use preferred stock with a variety of covenants. By way of contrast, in nations where the rule of law is less established, private equity groups are likely to use common stock and own the majority of the firm's equity if the investment encounters difficulties. Private equity groups based in the U.S. and U.K. rely more on preferred securities but also adapt transactions to local conditions. These contractual differences appear to have real consequences: larger transactions with higher valuations are seen in common law countries. These findings suggest that the structure of a country's legal system affects private contracts and cannot easily be undone by (bi-lateral) private solutions.

Abstract:
Public programs to provide early-stage financing to firms, particularly high-technology companies, have become commonplace in the United States and abroad. The long-run effectiveness of these programs, however, has attracted little empirical scrutiny. This paper examines the impact of the largest U.S. public venture capital initiative, the Small Business Innovation Research (SBIR) program, which has provided over $6 billion to small high-technology firms between 1983 and 1995. Using a unique database" of awardees compiled by the U.S. General Accounting Office, I show that SBIR awardees grew significantly faster than a matched set of firms over a ten-year period. The positive effects of SBIR awards were confined to firms based in zip codes with substantial venture capital activity. The findings are consistent with both the corporate finance literature on capital constraints and the growth literature on the importance of localization effects.

Abstract:
Government programs to finance small firms have attracted little empirical attention. This article examines the largest U.S. initiative, the Small Business Innovation Research program. Using a unique database, I show that program awardees grew significantly faster than matched firms over a decade and were more likely to attract venture financing. The superior performance of awardees was confined to firms in regions with substantial venture capital activity and was pronounced in high-technology industries. Multiple awards did not increase performance. These results suggest that awards played an important role in certifying firm quality but also that distortions of the award process occur.

Abstract:
The effectiveness of the many government programs to finance small firms has attracted little empirical attention. This paper examines the largest U.S. public venture capital initiative, the Small Business Innovation Research (SBIR) program, which has provided over $7 billion to small high-technology firms between 1983 and 1997. Using a unique database of awardees compiled by the U.S. General Accounting Office, I show that SBIR awardees grew significantly faster than a matched set of firms over a ten-year period. The superior performance of SBIR awardees was confined to firms based in zip codes with substantial venture capital activity. The impact of the awards was pronounced in high-technology industries. No increase of performance was associated with multiple awards. These patterns are consistent with the awards playing an important role in certifying firm quality, but also with some distortions of the award process.

Abstract:
The paper builds a tractable model of a patent pool, an agreement among patent owners to license a set of their patents to one another or to third parties. It first provides a necessary and sufficient condition for a patent pool to enhance welfare. It shows that requiring pool members to be able to independently license patents matters if and only if the pool is otherwise welfare reducing, a property that allows the antitrust authorities to use this requirement to screen out unattractive pools. The paper then undertakes a number of extensions. It evaluates the 'external test' according to which patents with substitutes should not be included in a pool; analyzes the welfare implications of the reduction in the members' incentives to invent around or challenge the validity of each other's patents; looks at the rationale for the (common) provision of automatic assignment of future related patents to the pool; and, last, studies the intellectual property owners' incentives to form a pool or to cross-license when they themselves are users of the patents in the pool.

Abstract:
The paper builds a tractable model of a patent pool, an agreement among patent owners to license a set of their patents to one another or to third parties. It first provides a necessary and sufficient condition for a patent pool to enhance welfare. It shows that requiring pool members to be able to independently license patents matters if and only if the pool is otherwise welfare reducing, a property that allows the antitrust authorities to use this requirement to screen out unattractive pools.

The paper then undertakes a number of extensions. It evaluates the "external test," according to which patents with substitutes should not be included in a pool; analyzes the welfare implications of the reductionin the members' incentives to invent around or challenge the validity of each other's patents; looks at the rationale for the (common) provision of automatic assignment of future related patents to the pool; and, last, studies the intellectual property owners' incentives to form a pool or to cross-license when they themselves are users of the patents in the pool.

Intellectual property, open and closed pools, essential patents, independent licensing, bogus patents

Abstract:
A long-standing controversy is whether LBOs relieve managers from short-term pressures from public shareholders, or whether LBO funds themselves are driven by short-term profit motives and sacrifice long-term growth to boost short-term performance. We investigate 495 transactions with a focus on one form of long-term activities, namely investments in innovation as measured by patenting activity. We find no evidence that LBOs are associated with a decrease in these activities. Relying on standard measures of patent quality, we find that patents granted to firms involved in private equity transactions are more cited (a proxy for economic importance), show no significant shifts in the fundamental nature of the research, and are more concentrated in the most important and prominent areas of companies' innovative portfolios.

Abstract:
A long-standing controversy is whether LBOs relieve managers from short-term pressures of dispersed shareholders, or whether LBO funds themselves are driven by short-term profit motives and sacrifice long-term growth to boost short-term performance. We investigate 495 transactions with a focus on one form of long-term activities, namely investments in innovation as measured by patenting activity. We find no evidence that LBOs decrease these activities. Relying on standard measures of patent quality, we find that patents applied for by firms in private equity transactions are more cited (a proxy for economic importance), show no significant shifts in the fundamental nature of the research, and are more concentrated in the most important and prominent areas of companies' innovative portfolios.

Buyouts, LBOs, Innovation, Patents

Abstract:
The impact of Microsoft on innovation in the computer software industry was fiercely debated during the recent antitrust case. This paper attempts to address this question through a new database that allows a comprehensive overview of patenting, venture capital financing, sales, and employment in the U.S. software industry between 1990 and 2000. While the conclusions must be necessarily tentative given the crudeness of my measures, I find little evidence consistent with the hypothesis that Microsoft has had a detrimental effect on innovation in the software industry, even after controlling for the possibility that possible that Microsoft targeted areas that also had the greatest potential for innovation and growth.

Abstract:
This paper examines the factors that lead to the creation of venture capital backed start-ups, a process we term entrepreneurial spawning.' We contrast two alternative views of the spawning process. In one view, employees of established firms are trained and conditioned to be entrepreneurs by being exposed to the entrepreneurial process and by working in a network of entrepreneurs and venture capitalists. Alternatively, individuals become entrepreneurs because the large bureaucratic companies for which they work are reluctant to fund their entrepreneurial ideas. Controlling for a firm's size, patent portfolio and industry, we find that the most prolific spawning firms were public companies located in Silicon Valley and Massachusetts that were themselves once venture capital backed. Less diversified firms are also more likely to spawn new firms. Spawning levels for these firms rise as their sales growth declines. Firms based in Silicon Valley and Massachusetts and originally backed by venture capitalists are more likely to spawn firms only peripherally related to their core businesses. Overall, these findings appear to be more consistent with the view that entrepreneurial learning and networks are important factors in the creation of venture capital backed firms.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
This paper examines the factors that lead to the creation of venture capital backed start-ups, a process we term "entrepreneurial spawning." We contrast two alternative views of the spawning process. In one view, employees of established firms are trained and conditioned to be entrepreneurs by being exposed to the entrepreneurial process and by working in a network of entrepreneurs and venture capitalists. Alternatively, individuals become entrepreneurs because the large bureaucratic companies for which they work are reluctant to fund their entrepreneurial ideas. Controlling for a firm's size, patent portfolio and industry, we find that the most prolific spawning firms were public companies located in Silicon Valley and Massachusetts that were themselves once venture capital backed. Less diversified firms are also more likely to spawn new firms. Spawning levels for these firms rise as their sales growth declines. Firms based in Silicon Valley and Massachusetts and originally backed by venture capitalists are more likely to spawn firms only peripherally related to their core businesses. Overall, these findings appear to be more consistent with the view that entrepreneurial learning and networks are important factors in the creation of venture capital backed firms.

Venture Capital, Entrepreneurship, Start-up

Abstract:
On numerous occasions, rival firms seek to market goods together, particularly in high-technology industries. This paper empirically examines one such institution: the patent pool. The analysis highlights five findings consistent with the theoretical predictions: (a) pools involving substitute patents are unlikely to allow pool members to license patents independently, consistent with our earlier theoretical work; (b) independent licensing is more frequently allowed when the number of members in the pool grows, which may reflect the increasing challenges that reconciling users? differing technological agendas pose in large pools; (c) larger pools are more likely to have centralized control of litigation, which may reflect either the fact that the incentives for individual enforcement in large pools are smaller or that large pools are more likely to include small players with limited enforcement capabilities; (d) third party licensing is more common in larger pools, consistent with suggestions that such pools were established primarily to resolve the bargaining difficulties posed by overlapping patent holdings; and (e) during the most recent era, when an intense awareness of antitrust concerns precluded many competition-harming patent pools, more important patents were selected for pools and patents selected for pools were subsequently more intensively referenced by others.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
On numerous occasions, rival firms seek to market goods together, particularly in high-technology industries. This paper empirically examines one such institution: the patent pool. The analysis highlights five findings consistent with the theoretical predictions: (a) pools involving substitute patents are unlikely to allow pool members to license patents independently, consistent with our earlier theoretical work; (b) independent licensing is more frequently allowed when the number of members in the pool grows, which may reflect the increasing challenges that reconciling users' differing technological agendas pose in large pools; (c) larger pools are more likely to have centralized control of litigation, which may reflect either the fact that the incentives for individual enforcement in large pools are smaller or that large pools are more likely to include small players with limited enforcement capabilities; (d) third party licensing is more common in larger pools, consistent with suggestions that such pools were established primarily to resolve the bargaining difficulties posed by overlapping patent holdings; and (e) during the most recent era, when an intense awareness of antitrust concerns precluded many competition-harming patent pools, more important patents were selected for pools and patents selected for pools were subsequently more intensively referenced by others.

Technology, Innovation, Licensing, Knowledge Sharing

Abstract:
This paper examines three sets of explanations for variations in the strength of patent protection across sixty countries and a 150-year period. Wealthier nations are more likely to have patent systems, to allow patentees a longer time to put their patents into practice, and to ratify treaties assuring equal treatment of other nations. But they are also likely to charge higher fees and limit patent protection in some important ways. Countries with democratic political institutions are consistently more likely to have patent protection appear to be determined by historical factors. The origin of a country's commercial law appears particularly important in explaining the presence of restrictions on patentees' privileges and discriminatory provisions against foreign patentees.

Abstract:
This paper examines three sets of explanations for variations in the strength of patent protection across sixty countries and a 150-year period. Wealthier nations are more likely to have patent systems, to allow patentees a longer time to put their patents into practice, and to ratify treaties assuring equal treatment of other nations. But they are also likely to charge higher fees and limit patent protection in some important ways. Countries with democratic political institutions are consistently more likely to have patent protection and to grant longer awards. Finally, many of the differences in patent policy appear to be determined by historical factors. The origin of a country's commercial law appears particularly important in explaining the presence of restrictions on patentees' privileges and discriminatory provisions against foreign patentees.

Abstract:
This paper empirically explores standard-setting organizations' policy choices. Consistent with Lerner-Tirole (2006), we find (a) a negative relationship between the extent to which an SSO is oriented to technology sponsors and the concession level required of sponsors and (b) a positive correlation between the sponsor-friendliness of the selected SSO and the quality of the standard. We also develop and test two extensions of the earlier model: the presence of provisions mandating royalty-free licensing is negatively associated with disclosure requirements, and the relationship between concessions and user friendliness is weaker when there is only a limited number of SSOs.

Forum shopping, innovation, licensing, standardization

Abstract:
This paper empirically explores the procedures employed by standard-setting organizations. Consistent with Lerner-Tirole (2004), we find (a) a negative relationship between the extent to which an SSO is oriented to technology sponsors and the concession level required of sponsors and (b) a positive correlation between the sponsor-friendliness of the selected SSO and the quality of the standard. We also develop and test two extensions of the earlier model: the presence of provisions mandating royalty-free licensing is negatively associated with disclosure requirements, and when there are only a limited number of SSOs, the relationship between concessions and user friendliness is weaker.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
This paper empirically explores the procedures employed by standard-setting organizations. Consistent with Lerner-Tirole (2004), we find (a) a negative relationship between the extent to which an SSO is oriented to technology sponsors and the concession level required of sponsors and (b) a positive correlation between the sponsor-friendliness of the selected SSO and the quality of the standard. We also develop and test two extensions of the earlier model: the presence of provisions mandating royalty-free licensing is negatively associated with disclosure requirements, and when there are only a limited number of SSOs, the relationship between concessions and user friendliness is weaker.

standardization, innovation, licensing, forum shopping

Abstract:
This paper seeks to better understand the competitive behavior of firms in standard-setting organizations by examining two case studies. We examine the development of mobile Internet standards by the Institute of Electrical and Electronics Engineers (IEEE); and the development of DSL standards. The case studies highlight that standard-setting bodies play critical roles in these industries. Because innovations are typically not promulgated by a single firm, but rather draw together technologies developed in multiple firms, the coordination role played by these organizations is critical. And certainly in some cases, particularly where parties commit in advance to a formal process (such as the xDSL one), the standardization process can lead to a dispassionate selection of a superior technology as a standard.

But as the IEEE 802.11 case suggests, the situation is often more complex. For in many cases, the selection of a technological standard has very substantial economic implications for the firms participating in the process. As a result, the standardization process can become side-tracked as warring factions seek to promote their own agenda. The process can be very much delayed as a result. Rules of standard-setting bodies that were originally intended to insure a fair process can be manipulated by firms to promote their own agenda or even to delay the project indefinitely. As a result, firms may be tempted to by-pass formal standards development organizations, and instead reach a private agreement with like-minded peers.

Standardization, innovation, technology

Abstract:
The theoretical analyses of patent pools almost exclusively assume that participation is automatic - any firm with a relevant patent and an option to join a patent pool is assumed to do so. But allowing firms to opt out of patent pools is a far more realistic assumption since all modern patent pools are voluntary. In this paper, we present empirical evidence on participation rates and the factors that drive the decision to join a pool. We also summarize the various profit sharing rules found in modern patent pools, and explore the consequences of the rule chosen. We find that vertically integrated firms are more likely to join a patent pool and among those firms that do join, those with relatively symmetric patent contributions to a standard appear more likely to accept numeric patent share rules for dividing royalty earnings.

Patent Pools, Standards Setting Organizations, Intellectual Property, Royalty Sharing

Abstract:
This article is an initial exploration of the determinants of open source license choice. It first highlights how the decision is shaped not just by the preferences of the licensor itself, but also by that of the community of developers. The article then presents an empirical analysis of the determinants of license choice using the SourceForge database, a compilation of nearly 40,000 open source projects. Projects geared toward end-users tend to have restrictive licenses, while those oriented toward developers are less likely to do so. Projects that are designed to run on commercial operating systems and whose primary language is English are less likely to have restrictive licenses. Projects that are likely to be attractive to consumers-such as games-and software developed in a corporate setting are more likely to have restrictive licenses. Projects with unrestricted licenses attract more contributors. These findings are broadly consistent with theoretical predictions.

Abstract:
This paper is an initial exploration of the determinants of open source license choice. It first enumerates the various considerations that should figure into the licensor's choice of contractual terms, in particular highlighting how the decision is shaped not just by the preferences of the licensor itself, but also by that of the community of developers. The paper then presents an empirical analysis of the determinants of license choice using the Source Forge database, a compilation of nearly 40,000 open source projects. Projects geared toward end-users tend to have restrictive licenses, while those oriented toward developers are less likely to do so. Projects that are designed to run on commercial operating systems and those geared towards the Internet are less likely to have restrictive licenses. Finally, projects that are likely to be attractive to consumers such as games are more likely to have restrictive licenses. A more tentative conclusion based on a much smaller sample is that projects that involve software developed in a corporate setting are likely to have more restrictive licenses. These findings are broadly consistent with theoretical predictions.

Abstract:
This paper is an initial exploration of the determinants of open source license choice. It first enumerates the various considerations that should figure into the licensor's choice of contractual terms, in particular highlighting how the decision is shaped not just by the preferences of the licensor itself, but also by that of the community of developers. The paper then presents an empirical analysis of the determinants of license choice using the SourceForge database, a compilation of nearly 40,000 open source projects. Projects geared toward end-users tend to have restrictive licenses, while those oriented toward developers are less likely to do so. Projects that are designed to run on commercial operating systems and those geared towards the Internet are less likely to have restrictive licenses. Finally, projects that are likely to be attractive to consumers--such as games--are more likely to have restrictive licenses. A more tentative conclusion based on a much smaller sample is that projects that involve software developed in a corporate setting are likely to have more restrictive licenses. These findings are broadly consistent with theoretical predictions.

Software, Contracting

Abstract:
While the variability of public equity financing has been long recognized, its impact on firms has attracted little empirical scrutiny. This paper examines one setting where theory suggests that variations in financing conditions should matter, alliances between small R&D firms and major corporations: Aghion and Tirole [1994] suggest that when financial markets are weak, assigning the control rights to the small firm may be sometimes desirable but not feasible. The performance of 200 agreements entered into by biotechnology firms between 1980 and 1995 suggests that financing availability does matter. Consistent with theory, agreements signed during periods with little external equity financing that assign the bulk of the control to the corporate partner are significantly less successful than other alliances. These agreements are also disproportionately likely to be renegotiated if financial market conditions improve.

Abstract:
This paper examines the sources of financial innovations between 1990 and 2002, using Wall Street Journal articles as indicators of innovations. No evidence suggests that larger firms are particularly innovative; in many specifications, there is a disproportionate representation of smaller firms among the innovators. Less profitable firms and those with stronger academic ties also innovate more. The elasticity of innovation with respect to size appears to have increased sharply since the State Street decision that greatly accelerated the rate of financial patenting. I conclude by exploring how the origins of financial patents resemble or differ from those of innovations.

Abstract:
This paper examines the sources of financial innovations between 1990 and 2002, using Wall Street Journal articles as indicators of innovations. No evidence suggests that larger firms are particularly innovative; in many specifications, there is a disproportionate representation of smaller firms among the innovators. Less profitable firms and those with stronger academic ties also innovate more. The elasticity of innovation with respect to size appears to have increased sharply since the State Street decision that greatly accelerated the rate of financial patenting. I conclude by exploring how the origins of financial patents resemble or differ from those of innovations.

discovery, invention, financial services, finance

Abstract:
The impact of private equity on employment arouses considerable controversy. Labor groups concerned about the fortunes of workers employed at buyout firms contend private equity firms destroy jobs. By contrast private equity associations and other groups have released a number of recent studies that claim positive effects of private equity on employment following the takeover. In this paper we conduct a comprehensive examination of the impact of private equity buyouts on the employment outcomes of firms that are taken over by these investment firms. We focus the analysis on two different dimensions. First, what are the employment outcomes of workers employed at establishments existing at the time of the buyout? Second, what is growth performance of the firm following the buyout? We conduct the analysis using a unique linked dataset covering the universe of US firms and information regarding US buyout operations between 1980 and 2005. We find targeted establishments exhibit net employment contraction, higher job destruction and establishment exit relative to controls. However, targeted firms exhibit higher greenfield entry and more acquisition and divestiture.

leveraged buyout, restructuring, creative destruction

Abstract:
Beginning in the late 1980s, American corporations began increasingly linking the compensation of central research personnel to the economic objectives of the corporation. This paper examines the impact of the shifting compensation of the heads of corporate research and development. Among firms with centralized R&D organizations, a clear relationship emerges: more long-term incentives (e.g. stock options and restricted stock) are associated with more heavily cited patents. These incentives also appear to be somewhat associated with more patent filings and patents of greater generality. We address endogeniety concerns in a variety of ways, including examining the impact of compensation for other key managers and utilizing an instrument based on spawning activity in the region. While we cannot determine whether the effect is due to better project selection or better people selection, the results continue to be consistent with our interpretation that performance pay of corporate R&D heads is associated with more innovative firms.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
Beginning in the late 1980s, American corporations began increasingly linking the compensation of central research personnel to the economic objectives of the corporation. This paper examines the impact of the shifting compensation of the heads of corporate research and development. Among firms with centralized R&D organizations, a clear relationship emerges: more long-term incentives (e.g. stock options and restricted stock) are associated with more heavily cited patents. These incentives also appear to be associated with more patent filings and patents of greater originality. Short-term incentives appear to be unrelated to measures of innovation.

research and development, laboratory, compensation

Abstract:
This paper empirically examines patents for financial formulas and methods, whose patentability was recently confirmed in the litigation between State Street Bank and Trust and Signature Financial Group. The number of such filings and awards has been accelerating. Patent filings by academics have been very infrequent, which appears to be a consequence of a lack of awareness or interest on the part of faculty members, rather than any fundamental unsuitability of their research for patenting. The failure to cite academic research in this area appears to be problematic and may reflect patent examiners' limited exposure to finance research and patents. The final section discusses the challenges that these developments pose to academic finance.

Abstract:
This paper empirically examines patents for financial formulas and methods, whose patentability was recently confirmed in the litigation between State Street Bank and Trust and Signature Financial Group. Awards by the U.S. Patent and Trademark Office have been accelerating in recent years, with a total of 445 financial patents awarded through February 2000. While the two largest recipients of these patents are major financial institutions, other awardees are very heterogeneous, including many computer hardware manufacturers and individual inventors. The role of universities in financial patenting has been modest, and the role of academic finance in delineating patent awards minimal. The final sections of the paper discuss the challenges that these developments pose to finance researchers and universities more generally.

Abstract:
This paper examines the direct private equity investment strategies across sovereign wealth funds and their relationship to the funds' organizational structures. SWFs seem to engage in a form of trend chasing, since they are more likely to invest at home when domestic equity prices are higher, and invest abroad when foreign prices are higher. Funds see the industry P/E ratios of their home investments drop in the year after the investment, while they have a positive change in the year after their investments abroad. SWFs where politicians are involved have a much greater likelihood of investing at home than those where external managers are involved. At the same time, SWFs with external managers tend to invest in lower P/E industries, which see an increase in the P/E ratios in the year after the investment. By way of contrast, funds with politicians involved invest in higher P/E industries, which have a negative valuation change in the year after the investment.

investments, public finance, private equity, general finance, countries & regions, financial services

Abstract:
Economists have debated the extent to which strengthening patent protection spurs or detracts from technological innovation. In this paper, we examine the reduction of software copyright protection in the Lotus v. Borland decision. If patent and copyright protections are substitutes, then weakening of one form of protection should be associated with an increasing reliance on the other. We find that the firms affected by the diminution of copyright protection disproportionately accelerated their patenting in subsequent years. But little evidence can be found for harmful effects: in fact, the increased reliance on patents is correlated with some positive outcomes for firms.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
Economists have debated the extent to which strengthening patent protection spurs or detracts from technological innovation. This paper examines the reduction of software copyright protection in the Lotus v. Borland decision. If patent and copyright protections are substitutes, weakening of one form should be associated with an increased reliance on the other. We find that the firms affected by the diminution of copyright protection disproportionately accelerated their patenting in subsequent years. But little evidence can be found for any harmful effects: in fact, the increased reliance on patents is correlated with growth in measures such as sales and R&D expenditures.

Abstract:
We document geographic concentration by both venture capital firms and venture capital-financed companies in three cities - San Francisco, Boston, and New York. We find that firms open new satellite offices based on the success rate of venture capital-backed investments in an area. Geography is also significantly related to outcomes. Venture capital firms based in locales that are venture capital centers outperform, regardless of the stage of the investment. Ironically, this outperformance arises from outsized performance outside of the venture capital firms' office locations, including in peripheral locations. Outperformance of non-local investments suggests that policy makers in regions without local venture capitalists might want to mitigate costs associated with established venture capitalists investing in their geographies rather than encouraging the establishment of new venture capital firms.

entrepreneurship, private equity, regional location

Abstract:
In April 2001, Allianz Capital Partners and Goldman Sachs acquired 66.2% of Messer Griesheim shares from pharmaceutical giant Hoechst, which later became Aventis. The remaining minority stake was owned by the Messer family. At EUR 2.1 billion, the buyout represented the largest private equity deals closed in Germany and the largest industrial buyout in Europe at that time. As private equity was gaining ground in Europe and Germany, the Messer Griesheim transaction epitomized a deal where a family regained control of some of its traditional, industrial‑based company's entities. An overall restructuring plan enabled the company to divest non‑core entities and focus on its core activities. Despite reductions in employment, employee development remained a critical issue for management throughout the deal, as the team provided incentives to encourage key employees to stay with the core businesses. The deal also successfully navigated the delicate nature of specific corporate governance aspects of a private equity‑backed family concern with global operations.

Private equity, family firm, employment, corporate governance

Abstract:
Owners of intellectual property or mere sponsors of an idea (e.g., authors, security issuers, sponsors of standards) often need to persuade potential buyers or adopters of the worth of their property or idea. To this purpose, they often resort to more or less independent certifiers. This paper analyzes the strategic choice of certifiers in rival and non-rival situations in a three-stage game. First, the owner/sponsor selects among potential certifiers. Certifiers differ in their degree of sympathy towards the owner/sponsor's interests relative to their concern for quality delivered to the users. Second, the certifier studies the offering and renders an opinion. The opinion consists of an endorsement (or lack thereof) and, possibly, some further demands for changes involving prices or offering characteristics. Third, the final users adopt or buy as a function of their perceived utility. In this context, the choice of certifier involves a basic trade-off: trying a tougher certifier reduces the probability of a positive opinion, but makes the users more likely to adopt the offering or willing to pay more for it in case of a positive opinion by the certifier. The paper first analyzes the sponsor's choices of certifier and design, as well as social preferences regarding these choices. More attractive standards lead to more friendly certification and fewer concessions to users. Regulation cannot improve on private choices in case of mildly attractive standards, and partial regulation reduces social welfare in case of attractive standards. Furthermore, the sponsor can costlessly delegate the design choice to the certifier when she can have her preferred choice of certifier, but must make more concessions to users than she would want to if the spectrum of certifiers is limited. The paper then extends the basic model to multiple categories of users, to the downstream presence of the sponsor, and to within-user-group network externalities. Finally, it studies strategic forum shopping by sponsors of competing standards.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
Owners of intellectual property or mere sponsors of an idea (e.g., authors, security issuers, sponsors of standards) often need to persuade potential buyers or adopters of the worth of their property or idea. To this purpose, they often resort to more or less independent certifiers. This paper analyzes the strategic choice of certifiers in rival and non-rival situations in a three-stage game. First, the owner/sponsor selects among potential certifiers. Certifiers differ in their degree of sympathy towards the owner/sponsor's interests relative to their concern for quality delivered to the users. Second, the certifier studies the offering and renders an opinion. The opinion consists of an endorsement (or lack thereof) and, possibly, some further demands for changes involving prices or offering characteristics. Third, the final users adopt or buy as a function of their perceived utility. In this context, the choice of certifier involves a basic trade-off: trying a tougher certifier reduces the probability of a positive opinion, but makes the users more likely to adopt the offering or willing to pay more for it in case of a positive opinion by the certifier. The paper first analyzes the sponsor's choices of certifier and design, as well as social preferences regarding these choices. More attractive standards lead to more friendly certification and fewer concessions to users. Regulation cannot improve on private choices in case of mildly attractive standards, and partial regulation reduces social welfare in case of attractive standards.

Furthermore, the sponsor can costlessly delegate the design choice to the certifier when she can have her preferred choice of certifier, but must make more concessions to users than she would want to if the spectrum of certifiers is limited. The paper then extends the basic model to multiple categories of users, to the downstream presence of the sponsor, and to within-user-group network externalities. Finally, it studies strategic forum shopping by sponsors of competing standards.

forum shopping, certification, standards

Abstract:
We examine a sample of over thirty thousand transactions by corporate and other venture organizations. Corporate venture investments in entrepreneurial firms appear to be at least as successful (using such measures as the probability of the portfolio firm going public) as those backed by independent venture organizations, particularly when there is a strategic overlap between the corporate parent and the portfolio firm. While corporate vendue capitalists tend to invest at a premium to other firms, this premium appears to be no higher in investments with a strong strategic fit. Finally, corporate programs without a strong strategic focus appear to be much less stable, frequently ceasing operations after only a few investments, but strategically focused programs appear to be as stable as independent venture organizations. The evidence is consistent with the existence of complementarities that allow corporations to effectively select and add value to portfolio firms, but is somewhat at odds with suggestions that the structure of corporate venture funds limits their effectiveness.

Abstract:
This paper examines the structure of over 100 alliances by Internet portals from 1995 to 1999. These alliances were an attractive empirical testing ground because of the large number and heterogeneous nature of the contracts, the high standards for disclosure in the industry, and the careful delineation of ownership, control, exclusivity, and other provisions in the contracts. The division of ownership and allocation of control rights displayed patterns consistent with the predictions in the incomplete contracting literature. Similarly, the exclusivity
of the agreements appeared to vary, at least weakly, with the value of the product or service being made available to the portal, consistent with the licensing literature. In other cases, particularly in regard to the differing allocation of ownership and control and the varying completeness of the contracts, the empirical patterns indicated a more complex world than the one that theory led us to anticipate.

Abstract:
This paper examines the structure of over 100 alliances by Internet portals from 1995 to 1999. These alliances were an attractive empirical testing ground because of the large number and heterogeneous nature of the contracts, the high standards for disclosure in the industry, and the careful delineation of ownership, control, exclusivity, and other provisions in the contracts. The division of ownership and allocation of control rights displayed patterns consistent with the predictions in the incomplete contracting literature. Similarly, the exclusivity of the agreements appeared to vary, at least weakly, with the value of the product or service being made available to the portal, consistent with the licensing literature. In other cases, particularly in regard to the differing allocation of ownership and control and the varying completeness of the contracts, the empirical patterns indicated a more complex world than the one that theory led us to anticipate.

Abstract:
Purpose
This papers analyses the case study of UK fashion retailer New Look and focuses on the impact of private equity on corporate governance, employment and leverage after the public-to-private transaction in 2003.

Design/methodology/approach
We follow a single case study approach to offer in-depth insights into the role of different parties involved in the deal and their perceptions. Our case study is based on semi-structured interviews with key management of New Look, partners of the private equity firms and other important members of the New Look board. In addition, we complemented our analysis with secondary sources (e.g. analyst reports, published articles and financial data of New Look) in order to triangulate our findings.

Findings
The case presents an example of a company that pursued a public-to-private transaction with the support of private equity partners. The envisioned transformation process post-transaction turned out to be highly successful with increasing efficiencies and profits as well as an increase of over 3,500 employees over four years. This paper analyses key success drivers and the role of the private equity partners in achieving this success.

Originality/value
Our paper is the first in-depth case study of a European public-to-private transaction with support of private equity which offers rich evidence on the impact of private equity on corporate governance, employment and leverage.

Private equity, going private, employment, corporate governance

Abstract:
This paper provides a simple model of licensing intellectual property to licensees who sell complementary products, revenues from which are at least partially uncontractible. When the licensor cannot use fixed fees, he prefers output-based royalties over profit-sharing agreements if the licensee's revenues from complements are not too high and if the fraction thereof that can be brought under the incidence of a licensing agreement is sufficiently large. The public policy implication is that, in such licensing contexts, there is a compelling case for broadening the ability of licensors to share in revenues from sales of adjacent products in order to allow for the internalization of externalities due to product complementarities. We illustrate our arguments with two case studies: licensing of printer technology to Dell and licensing of music to Apple Computer.

license, patent, technology transfer

Abstract:
An extensive theoretical literature has examined the impact of information problems on interactions between government bodies and private firms. One little-explored empirical testing ground is the patent system. This paper examines the administrative practices of patent offices in sixty countries over a 150-year period. I show that the usage of patent renewal fees and other mechanisms to grant discretion to patentees is consistent with theoretical suggestions. Nations where information asymmetries between government officials and patentees are likely to be more prevalent-larger countries, wealthier economies, and those where international trade is more important-incorporate discretionary features into their patent systems more frequently. I also find evidence that policymakers are more likely to restrict patent office officials` flexibility and to divide the responsibility for determining patentability between the patent office and the courts when information problems are likely to be severe.

Abstract:
An extensive theoretical literature has examined the impact of information problems on interactions between government bodies and private firms. One little-explored empirical testing ground is the patent system. This paper examines the administrative practices of patent offices in sixty countries over a 150-year period. I show that the usage of patent renewal fees and other mechanisms to grant discretion to patentees is consistent with theoretical suggestions. Nations where information asymmetries between government officials and patentees are likely to be more prevalent?larger countries, wealthier economies, and those where international trade is more important?incorporate discretionary features into their patent systems more frequently. I also find evidence that policymakers are more likely to restrict patent office officials? flexibility and to divide the responsibility for determining patentability between the patent office and the courts when information problems are likely to be severe.

Abstract:
The appropriate role of the public sector in fomenting venture capital activity remains highly controversial. While dynamic new venture markets in such nations as Israel and India have been catalyzed by public interventions, there are also many examples world-wide of failed public sector efforts to promote venture capital activity. This paper describes one effort to avoid the pitfalls of the past, and design a thoughtful set of policies to encourage venture capital activity.

In particular, this paper describes the experience of the Australian government between 2004 and 2006 in studying its venture capital market and how to promote it. After reviewing the more general case for a public role in promoting venture activity and the possible pitfalls that may result, we turn to understanding the market as it existed in Australia in 2004. We then outline the key policies that were discussed and adopted.

private equity, entrepreneurship, public policy

Abstract:
In recent years, there has been a growth in interest among economists in the litigation of intellectual property, as opposed the traditional focus on the grants of these rights and their subsequent citation in other awards. This new focus is very natural, given the critical importance of the litigation process in enforcing intellectual property rights. To date, though, the literature on litigation of intellectual property rights has almost exclusively focused on patents. This orientation is readily understandable: not only are patents a critically important property right, but they are also relatively straightforward to track. The major alternative forms of protection, such as trade secrets and copyrights, are often more difficult to empirically examine.

Despite these challenges, trade secrets are a key form of protection for many firms that either choose not to or cannot patent their discoveries. Thus, in this paper I seek to explore what can be gleaned empirically about this form of protection using the recorded decisions associated with trade secret-related civil litigation.

intellectual property, litigation, technological change

Abstract:
We analyze how variations in contractibility affect the design of contracts in the context of biotechnology research agreements. A major concern of firms financing biotechnology research is that the R&D firms might use the funding to subsidize other projects or substitute one project for another. We develop a model based on the property-rights theory of the firm that allows for researchers in the R&D firms to pursue multiple projects. When research activities are non-verifiable, we show that it is optimal for the financing company to obtain the option right to terminate the research agreement while maintaining broad property rights to the terminated project. The option right induces the biotechnology firm researchers not to deviate from the proposed research activities. The contract prevents opportunistic exercise of the termination right by conditioning payments on the termination of the agreement. We test the model empirically using a new data set on 584 biotechnology research agreements. We find that the assignment of termination and broad intellectual property rights to the financing firm occurs in contractually difficult environments in which there is no specifiable lead product candidate. We also analyze how the contractual design varies with the R&D firm's financial constraints and research capacities and with the type of financing firm. The additional empirical results allow us to distinguish the property-rights explanation from alternative stories, based on uncertainty and asymmetric information about the project quality or research abilities.

Abstract:
The pervasiveness of research agreements between pharmaceutical and biotechnology companies is puzzling, since it is hard to contract on the exact nature of the research activities. A major concern of financing companies is that the R&D firms use their funding to subsidize other projects or substitute one project for another. We develop a model based on the property-rights theory of the firm that allows for researchers in the R&D firms to pursue multiple tasks. When research activities are non-contractible, we show that it is optimal for the financing company to obtain the option right to terminate the research agreement while maintaining the property rights to the terminated project. This right will induce the biotechnology firm researchers not to deviate from the proposed research activities. The contract prevents opportunistic exercise of this termination right by conditioning payments on the termination of the agreement. We test the model empirically using a new data set on 584 biotechnology research agreements. We find that the assignment of termination and ownership rights to the financing firm occurs in contractually difficult environments in which the parties cannot specify the lead product candidate. We employ further empirical tests to distinguish the property-rights explanation from alternative stories, based on uncertainty and asymmetric information about the project quality or research abilities.

Abstract:
Government bodies have been playing an active and frequently controversial role in many standards competitions in recent decades. The growing literature on standards by economists has largely neglected this role. This paper seeks to take an initial step in addressing this gap in the literature, by examining the experience of one current, and quite contentious, public effort to promote a standard: the Chinese efforts to promote a wireless networking standard and the ensuing interactions with the efforts to create a standard in Europe and the United States.

We highlight several observations from this case, which are particularly striking when we contrast this with the experience of the 802.11 technology - which also facilitates wireless computer networking - developed in the West. First, the role of the public sector was quite different. The development of the 802.11 standards in the Institute of Electrical and Electronics Engineers was driven by major technology firms, both within the standardization body and through the non-profit Wi-Fi Alliance, which played a more aggressive promotional role. Much of the success of the firms in promoting technologies that they had sponsored seemed to be driven by their size and market power. The WAPI process, on the other hand, was almost completely driven by the public sector. There was no significant investment by any major technology firm.

Unlike the WAPI process - where the initial technology did not mature in the market, but was almost immediately sponsored by the national standardization body - the 802.11 standard was developed over time. Various companies brought forward technologies that they had developed, and in many cases refined in the marketplace and sought to obtain super-majority approvals from the IEEE. The standardization process was transparent and open for all who wished to participate. By way of contrast, substantial ambiguities surrounded the WAPI program. For instance, the objectives of the national standardization body sponsoring the project was a mystery. Some speculated that there were two factions (with more and less pro-market views) that were fighting over how and whether WAPI should be made into an international standard.

The treatment of intellectual property was quite different as well. The IEEE standardization included requirements that firms make their intellectual property available on reasonable and non-discriminatory terms. At the same time, at least some ambiguities appear to have surrounded the nature of the commitments to make intellectual property available: the IEEE required disclosure, but the terms of disclosure were not entirely clear. With WAPI, on the other hand, there were considerable ambiguities surrounding the technology, with no access to relevant intellectual property. The only way to build to the technology was to partner with one of 24 firms involved in the promulgating the standard, but the nature of these partnerships was unclear, and outside firms worried about revealing related intellectual property in exchange.

The disparities in the strategies adopted by Western and Chinese governments correspond to the typologies developed in the theoretical literature. At the same time, the realities of the two cases raise a variety of questions that have not been explicitly considered by economists, such as the appropriate strategy in settings where less developed nations are competing with established countries. It is hard to conclude that either the bottom up approach of IEEE or the top-down national approach of China was necessarily superior: each may have been appropriate given the different circumstances of the nations.

intellectual property, licensing, patents

Abstract:
We test theoretical propositions from the literature on information and control in interfirm agreements using a sample of over 100 Internet portal alliance contracts. The literature on information and control in alliances suggests that the use of verifiable performance measures to allocate state-contingent control rights depends (a) on the precision of the information about the realized state and (b) on the level of information asymmetry between the two parties regarding the preferences of each. We test these propositions by looking at how the timing of agreements (a proxy for environmental uncertainty) and exclusivity restrictions (a proxy for incentive conflict) impact the use of a subset of available performance measures. Consistent with a signaling model of the allocation of contingent control rights, we find that contracts involve fewer contingent control rights as industries have matured. Where incentive conflicts are potentially greater, more contingent control rights are used.

Incomplete contracts, alliances, control rights

Abstract:
This paper examines several recent avenues of empirical research into the enforcement of" intellectual property rights. To frame these issues, we start with a stylized model of the patent" litigation process. The bulk of the paper is devoted to linking the empirical literature on patent" litigation to the parameters of the model. The four major areas we consider are (i) how the" propensity to litigate patents varies with the expected benefits of litigation the cost of litigation affects the willingness to enforce patents, (iii) how the cost of enforcing" patents changes the private value of patent rights, and (iv) the impact of intellectual property" litigation on the innovation process itself.

Abstract:
This paper argues that a large component of success in entrepreneurship and venture capital can be attributed to skill. We show that entrepreneurs with a track record of success are more likely to succeed than first time entrepreneurs and those who have previously failed. Funding by more experienced venture capital firms enhances the chance of success, but only for entrepreneurs without a successful track record. Similarly, more experienced venture capitalists are able to identify and invest in first time entrepreneurs who are more likely to become serial entrepreneurs. Investments by venture capitalists in successful serial entrepreneurs generate higher returns for their venture capital investors. This finding provides further support for the role of skill in both entrepreneurship and venture capital.

Abstract:
The paper seeks to understand the impact of the patent system on innovation by examining shifts in the strength of patent protection across sixty countries and a 150-year period. An examination of 177 policy changes reveals that strengthening patent protection appears to have few positive effects on patent applications by entities in the country undertaking the policy change, whether filings in Great Britain or the nation making the policy change are considered. Cross-sectional analyses suggest that the impact of patent protection-enhancing shifts were greater in nations with weaker initial protection and greater economic development, consistent with economic theory. I address concerns about the endogeneity of these changes by employing an instrumental variable approach.