Contracting Frictions and Cross-Border Capital Flows: Evidence from Venture Capital
36 Pages Posted: 19 Feb 2009
Date Written: November 2008
Analyzing a large sample of cross-border investments by U.S. venture capital firms, we find that average round sizes and the fraction of financing raised in the first round are larger for companies in countries with poorer legal enforcement. This evidence, which is consistent with third-best contracting where investors take larger stakes to mitigate contractual enforcement problems, suggests that the staging of investments in weak enforcement countries may be less than an optimal. We develop a contracting friction measure, based on the degree of sub-optimal staging, and find that it is negatively related to aggregate cross-border venture capital flows. We interpret the evidence as consistent with a "staging channel" through which frictions that lead to third-best contracting and sub-optimal staging limit cross-border investment.
Keywords: Venture capital, cross-border, contracting
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