The Effect of Inter-firm Ties on Performance in Financial Markets

Abstract

The present study examines the effect of the information obtained through close inter-firm ties on the investor’s risk-adjusted returns. We suggest that there is a closely connected tie between an investor and an entrepreneurial firm if the investor is a limited partner of the entrepreneurial firm’s lead venture capital (VC) fund. We hypothesize that such closely connected ties convey credible, timely, and precise information regarding the underlying value of the entrepreneurial firm, which is especially valuable when market conditions are unfavorable and when the investor faces higher information asymmetry. Supporting our hypotheses, we show that investors with closely connected ties to entrepreneurial firms receive higher returns on their investments, and their returns are particularly high when investor sentiment is low (unfavorable market conditions) and when there is higher information asymmetry due to greater geographical distance.

Keywords: interorganizational ties, information asymmetry, investor sentiment, investment returns, venture capital

JEL Classification: L14, L26, G11, G24