The Trade-Off of Governments as Venture Capitalists

Abstract

By exploiting a unique policy experiment in China and difference-in-differences methodology, I find that government investments crowd in private investments, with a multiplier of 0.88-0.93. The impact is most pronounced in less developed regions and during the early development of the VC sector. I further show micro-level evidence of the crowding-in effects through network linkages among limited partners and VC firms, consistent with the signaling role of government investments. However, government VCs come at the cost of underperformance. I find a negative performance gap, amounting to 87.5% of the sample mean, between government and private VCs as 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