Download this Paper Open PDF in Browser

Unleashing Innovation

54 Pages Posted: 6 Oct 2013 Last revised: 13 Nov 2014

Yifei Mao

Cornell University - SC Johnson College of Business - Finance Department

Xuan Tian

Tsinghua University - PBC School of Finance

Xiaoyun Yu

Indiana University - Kelley School of Business - Department of Finance; China Academy of Financial Research (CAFR)

Date Written: November 4, 2014

Abstract

Using a sample of venture capital (VC)-backed initial public offering (IPO) firms, we study the effect of financial intermediaries’ tight leash on entrepreneurs’ innovation productivity. We find that financial intermediaries’ tight leash impedes innovation: IPO firms are significantly less innovative when VCs interfere with their development more frequently through staging — as measured by a larger number of VC financing rounds. To establish causality, we exploit plausibly exogenous variation in the frequency of direct flights between VC domiciles and IPO firm headquarters that are due to airline restructuring. Our identification tests suggest a negative, causal effect of VC staging on firm innovation. Furthermore, staging is more detrimental to innovation when innovation is more difficult to achieve and when VCs are less experienced with the industry in which their entrepreneurial firms operate. By documenting a previously under-recognized adverse consequence of VC stage financing, our evidence suggests that contract mechanisms are at play so that short-termist incentives can be cultivated even in a private equity market populated with long-term, sophisticated investors.

Keywords: Innovation, Stage financing, Venture capital, Short-termism

JEL Classification: G24, O31, G34

Suggested Citation

Mao, Yifei and Tian, Xuan and Yu, Xiaoyun, Unleashing Innovation (November 4, 2014). Kelley School of Business Research Paper No. 2014-43. Available at SSRN: https://ssrn.com/abstract=2336309 or http://dx.doi.org/10.2139/ssrn.2336309

Yifei Mao

Cornell University - SC Johnson College of Business - Finance Department ( email )

Ithaca, NY 14850
United States

Xuan Tian (Contact Author)

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengfu Road
Haidian District
Beijing 100083
China
+86-10-62794103 (Phone)

HOME PAGE: http://xuantian.info/

Xiaoyun Yu

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3521 (Phone)
812-855-5875 (Fax)

China Academy of Financial Research (CAFR)

1954 Huashan Road
Shanghai P.R.China, 200030
China

Paper statistics

Downloads
501
Rank
45,901
Abstract Views
2,485