Competition and Specialization: A Non-Monotonic Relationship

Christos Cabolis

ALBA Graduate Business School; Yale SOM International Center for Finance

Mian Dai

Drexel University

Konstantinos Serfes

Drexel University--School of Economics

October 6, 2014

We investigate the relationship between competition and firm specialization in the venture capital (VC) market. Staged financing motivates VC firms to fund entrepreneurs in various states of maturity: startup/seed, early, growth, and so forth, and leads to stage specialization. Contrary to the conventional wisdom that competition always promotes specialization, we find an inverted-U relationship, using panel data on VC funding rounds in the U.S. between 1980 and 2006. We develop a matching model with two-sided vertical heterogeneity, bilateral bargaining and moral hazard to demonstrate that the non-monotonicity is driven by the expected utility VC firms offer to entrepreneurs, via equity stakes, where higher quality entrepreneurs (with more promising business plans) receive greater utility. Competition shifts and rotates the utility schedule, which gives rise to two opposing forces on the returns to specialization as competition intensifies. We then search for validation of the mechanism we propose and we find consistent empirical evidence.

Number of Pages in PDF File: 44

Keywords: Venture capital market, Stage specialization, Competition, Endogenous matching

JEL Classification: G24, D4, C7

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Date posted: March 8, 2014 ; Last revised: October 7, 2014

Suggested Citation

Cabolis, Christos and Dai, Mian and Serfes, Konstantinos, Competition and Specialization: A Non-Monotonic Relationship (October 6, 2014). Available at SSRN: http://ssrn.com/abstract=2405829 or http://dx.doi.org/10.2139/ssrn.2405829

Contact Information

Christos Cabolis
ALBA Graduate Business School ( email )
6-8 Xenias Street
Athens, 115 28
+30 210 896 4531 (Phone)
+30 210 896 4737 (Fax)
HOME PAGE: http://www.alba.edu.gr/faculty/Pages/Cabolis.aspx
Yale SOM International Center for Finance ( email )
135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-7108 (Phone)
203-432-8931 (Fax)
Mian Dai
Drexel University ( email )
Philadelphia, PA 19104
United States
Konstantinos Serfes (Contact Author)
Drexel University--School of Economics ( email )
3141 Chestnut St.
Philadelphia, PA 19104
United States
215-895-6816 (Phone)
215-571-4670 (Fax)
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