The Market for Innovation in the United States and Japan: Venture Capital and the Comparative Corporate Governance Debate

Abstract

To date, the comparative corporate governance debate has focused on the reduction of agency costs rather than the ability of a given economic system to encourage the funding and monitoring of innovative new businesses. This paper explores the linkage between corporate governance and innovation by examining the different institutional environments for venture capital in the United States and Japan. The paper begins by outlining the practical and theoretical importance of venture capital, which has been largely overlooked in legal literature. It then profiles the venture capital markets of the United States and Japan, showing that U.S. venture capital funds are larger and more independent, hold larger equity stakes in and take a more active role in the management of portfolio companies, make more early-stage investments, and invest more heavily in new technologies than their Japanese counterparts. The paper traces the sources of these differences to prevailing traits of the corporate governance systems of the two countries, isolating five traits of the U.S. market-oriented governance system that increase the supply of and demand for risk capital, and showing why these traits are not found in Japan's bank-oriented system. The paper concludes that the venture capital market in Japan is constrained by the very institutional framework that is applauded by commentators working from an agency cost perspective, underscoring the need to include innovation in the comparative corporate governance debate.

JEL Classification: G24, G34