How Does Venture Capital Financing Improve Efficiency in Private Firms? A Look Beneath the Surface

60 Pages Posted: 22 Jul 2009

See all articles by Thomas J. Chemmanur

Thomas J. Chemmanur

Boston College - Carroll School of Management

Karthik Krishnan

Northeastern University

Debarshi K. Nandy

Brandeis University - International Business School

Multiple version iconThere are 2 versions of this paper

Date Written: June 1, 2008

Abstract

Using a unique sample from the Longitudinal Research Database (LRD) of the U.S. Census Bureau, we study several related questions regarding the efficiency gains generated by venture capital (VC) investment in private firms. First, does VC backing improve the efficiency (total factor productivity, TFP) of private firms, and are certain kinds of VCs (higher reputation versus lower reputation) better at generating such efficiency gains than others? Second, how are such efficiency gains generated: Do venture capitalists invest in more efficient firms to begin with (screening) or do they improve efficiency after investment (monitoring)? Third, how are these efficiency gains spread out over rounds subsequent to VC investment? Fourth, what are the channels through which such efficiency gains are generated: increases in product market performance (sales) or reductions in various costs (labor, materials, total production costs)? Finally, how do such efficiency gains affect the probability of a successful exit (IPO or acquisition)? Our main findings are as follows. First, the overall efficiency of VC backed firms is higher than that of non-VC backed firms. Second, this efficiency advantage of VC backed firms arises from both screening and monitoring: the efficiency of VC backed firms prior to receiving financing is higher than that of non-VC backed firms and further, the growth in efficiency subsequent to receiving VC financing is greater for such firms relative to non-VC backed firms. Third, the above increase in efficiency of VC backed firms relative to non-VC backed firms increases over the first two rounds of VC financing, and remains at the higher level till exit. Fourth, while the TFP of firms prior to VC financing is lower for higher reputation VC backed firms, the increase in TFP subsequent to financing is significantly higher for the former firms, consistent with higher reputation VCs having greater monitoring ability. Fifth, the efficiency gains generated by VC backing arise primarily from improvement in product market performance (sales); however for higher reputation VCs, the additional efficiency gains arise from both an additional improvement in product market performance as well as from reductions in various input costs. Finally, both the level of TFP of VC backed firms prior to receiving financing and the growth in TFP subsequent to VC financing positively affect the probability of a successful exit (IPO or acquisition).

Suggested Citation

Chemmanur, Thomas J. and Krishnan, Karthik and Nandy, Debarshi K., How Does Venture Capital Financing Improve Efficiency in Private Firms? A Look Beneath the Surface (June 1, 2008). US Census Bureau Center for Economic Studies Paper No. CES-WP- 08-16. Available at SSRN: https://ssrn.com/abstract=1427846 or http://dx.doi.org/10.2139/ssrn.1427846

Thomas J. Chemmanur (Contact Author)

Boston College - Carroll School of Management ( email )

Finance Department, 436 Fulton Hall
Carroll School of Management, Boston College
Chestnut Hill, MA 02467-3808
United States
617-552-3980 (Phone)
617-552-0431 (Fax)

HOME PAGE: http://https://www2.bc.edu/thomas-chemmanur/

Karthik Krishnan

Northeastern University ( email )

360 Huntington Avenue
414C Hayden Hall
Boston, MA 02115
United States
617-373-4707 (Phone)

HOME PAGE: http://www.northeastern.edu/kkrishnan

Debarshi K. Nandy

Brandeis University - International Business School ( email )

Mailstop 32
Waltham, MA 02454-9110
United States

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