An Empirical Examination of Management of Real Options in the U.S. Venture Capital Industry

Abstract

This study empirically examines how firms manage real options over time in the context of the U.S. venture capital industry. It tracks the venture-capital funding histories of U.S. portfolio companies founded during 1989-1993, and their outcomes, until 2004. An examination of sequential investments suggests asymmetries in the management of successful and unsuccessful companies. Signals of a company’s progress, such as the number of its patents, are significant predictors of VC investment practices in the case of successful companies, but not in the case of unsuccessful companies. In contrast, VC firm characteristics, such as experience in the company’s industry, IPO experience, and geographic proximity, appear to explain variance in investment policies for unsuccessful companies, but not successful ones. This suggests that signals of progress are relatively easier to interpret when the real options perform well over time, and investors can perhaps apply them equally effectively. In contrast, signals of failure are more ambiguous and complex; and firm-level differences are more pronounced in management of unsuccessful options.