A Two-Sided Story of Governments as Venture Capitalists

Abstract

This paper shows that government investments have both bright and dark sides in fostering the development of venture capital (VC). Exploiting a unique policy experiment in China and difference-in-difference methodology, I find that government investments crowd in private investments, with a multiplier of 0.88-0.93. Consistent with the signaling role of government investments, the positive impact is most pronounced in relatively less developed regions and during the early development of the VC sector. I further show micro-level evidence of the crowding-in effects through limited partner co-investment networks and VC joint affiliates. However, government investments also have the cost of underperformance. I find a negative performance gap, amounting to 87.5% of the sample mean, between government and private VCs measured by how likely their portfolio companies exit through IPOs. Supporting the agency and the political views of governments, the performance gap is smaller in more competitive markets and larger in turnover years of local politicians.

Keywords: government programs, venture capital, quasi-experiment, crowding-in, social finance, network analysis, underperformance, IPO exits.

JEL Classification: G24; G28; H76; O38