Venture Capital in Emerging Economies: Networks and Institutional Change

Abstract

Emerging economies lack the regulations,enforcement, and rule of law that venture capitalists are accustomed to inestablished economies. This study explores how venture capitalists use networkrelationships among entrepreneurs, venture capitalists, and enterprises andother informal institutions to make and manage investments in ways tosupplement or replace weak, lacking, or unstable formal institutions inemerging markets. Institutional theory, which adds social and cultural elements, is used toprovide a more socialized explanation about how networks can affect thefunction of venture capitalists. A grounded theory approach is used to gatherdata about the institutional effects on venture capital. Four principalcategories of venture capital activities are firm selection and due diligence,structuring and monitoring, value-added, and exit. A model of venturecapitalist behavior was based on 65 semi-structured interviews with venturecapital fund managers and government officials in Hong Kong, Thailand, China,Singapore, Taiwan, and South Korea from 1999 to 2003. It was found that venture capitalists needed to have knowledge of thefriends and families of the enterprise founders as part of the selectionprocess; and entrepreneurs' connections with government officials were deemedimportant. Monitoring the firm is especially important given weak or poorlyenforced legal environments. Monitoring is done through board seats oremploying junior staff members. There are limits on ways thatventurecapitalists can add value to their investments, sinceentrepreneurs candisregard wishes of venture capitalists and their board; hence networkrelations are used to influence firm direction. The ability to exit the ventureis constrained because ability to list a firm is limited, the corporate controlmarket is weak, and enforceable bankruptcy codes often do not exist. Overall, it was found that in emerging economies networks are used forinformation purposes, and as substitutes for formal institutions such as ruleof law, monitoring, and contract enforcement. The analysis has drawn attentionto the impact of networks and changing institutional environments during thetransition process in emerging economies. (TNM)

Keywords: Organization theory, Monitoring, Contract compliance, Oversight, Legal systems, Venture capital, Startups, Institutional collaboration, Emerging markets, Social networks, Firm control, Informal networks, Legal protection, Due diligence, Venture capitalists, Contracts & agreements