Tolerance for Failure and Corporate Innovation

Abstract:     
We examine whether tolerance for failure spurs corporate innovation based on a sample of venture capital (VC) backed IPO firms. We develop a novel measure of VC investors’ failure tolerance. We find that IPO firms backed by more failure-tolerant VC investors are significantly more innovative. A rich set of empirical tests shows that this result is not driven by the endogenous matching between failure-tolerant VCs and startups with high ex-ante innovation potentials. Further, we find that being financed by a failure-tolerant VC is much more important for ventures with high potentials than for those with low potentials. We also find that the effect of failure tolerance on innovation persists long after VC investors exit the IPO firms, and the effect is even more persistent if the startup firms start to interact with the VCs in the firms’ early development stages. Such persistence suggests that VC investors’ attitudes toward failure have likely been internalized by the startup firms and become part of the firms’ culture.

Keywords: tolerance for failure, innovation, patents, venture capital, IPO, corporate culture

JEL Classifications: M14, O31, G24, G34

Working Paper Series