Entrepreneurial Finance Meets Organizational Reality: Comparing Investment Practices and Performance of Corporate and Independent Venture Capitalists

Abstract

This paper investigates the effect of compensation of corporate personnel on their investment in new technologies. To that end, we focus on a specific corporate activity, namely Corporate Venture Capital (CVC), describing minority equity investment by established firms in entrepreneurial ventures. The setting offers an opportunity to compare corporate investors to investment experts, the independent VCs. On average, we observe a performance gap between corporate investors and their independent counterparts. Interestingly, the performance gap is sensitive to CVCs’ compensation scheme: it is the largest when CVC personnel are awarded performance-pay (e.g., carried interest). Not only do we study the association between incentives and performance, but also we document a direct relationship between incentives and the actions managers undertake. For example, we observe disparity between the number of participants in venture capital syndicates that involve a corporate investor, and those that consist solely of independent VCs. The differences persist after controlling for numerous factors including CVC’s objectives. The disparity shrinks substantially, however, for a subset of CVC programs that compensate their personnel using performance-pay. We find a parallel pattern when analyzing the relationship between compensation and another investment practice, staging of investment. To conclude, the paper investigates the three elements of the principal-agent framework thus providing direct evidence that compensation schemes (incentives) shape investment practices (managerial action) and ultimate investors’ outcome (performance).

Keywords: Principal-Agent, Incentives, Corporate Venture Capital, Corporate Entrepreneurship