Venture Capital and Innovation: Which is First?
University of Wisconsin, Madison - School of Business; Centre for Economic Policy Research (CEPR)
Northern Illinois University - Department of Economics
September 14, 2008
Policy makers typically interpret positive relations between venture capital investments and innovations as an evidence that venture capital investments stimulate innovation ("VC-first hypothesis"). This interpretation is, however, one-sided because there may be a reverse causality that innovations induce venture capital investments ("innovation-first hypothesis"): an arrival of new technology increases demands for venture capital by driving new firm startups. We analyze this causality issue of venture capital investments and innovation in the US manufacturing industry using both total factor productivity (TFP) growth and patent counts as measures of innovation. Using a panel AR regression as well as industry-by-industry AR regressions, we find that TFP growth is often positively and significantly related with future VC investment, which is consistent with the innovation-first hypothesis. We find little evidence that supports the VC-first hypothesis. More surprisingly, one-year lagged VC investments are often negatively and significantly related with both TFP growth and patent counts.
Number of Pages in PDF File: 45
Keywords: Venture Capital, Innovation, Granger-Causality
JEL Classification: G24, D24, O31, O32
Date posted: August 22, 2008 ; Last revised: September 15, 2008
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