29 Pages Posted: 8 Mar 2014 Last revised: 26 May 2017
Date Written: May 24, 2017
The central theme of this paper is how competition affects certain aspects of a firm's internal organizational structure. More specifically, we investigate the relationship between competition and stage specialization in the venture capital (VC) market. Stage financing is used as a mechanism to better align the goals of investors and entrepreneurs through the achievement of certain milestones. A typical successful company goes through multiple stages of VC investments, but an average VC firm specializes and participates only in a subset of these stages. We develop an infinitely repeated game of VC competition, where VC firms make stage specialization decisions (either invest in one of the two stages, or in both) and compete in equity offers to entrepreneurs. Contrary to conventional wisdom that competition always promotes specialization, the model predicts that the relationship between competition and stage specialization is non-monotonic. Using panel data on VC funding rounds in the U.S., and consistent with the theoretical prediction, we find an inverted-U relationship between competition and stage specialization.
Keywords: Venture capital market, Stage specialization, Competition, Endogenous matching
JEL Classification: G24, D4, C7
Suggested Citation: Suggested Citation
Cabolis, Christos and Dai, Mian and Serfes, Konstantinos, Competition and Specialization in the VC Market: A Non-Monotonic Relationship (May 24, 2017). Available at SSRN: https://ssrn.com/abstract=2405829 or http://dx.doi.org/10.2139/ssrn.2405829