Catching Outliers: Committee Voting and the Limits of Consensus when Financing Innovation

73 Pages Posted: 16 Jun 2021 Last revised: 7 Feb 2023

See all articles by Andrey Malenko

Andrey Malenko

University of Michigan, Stephen M. Ross School of Business; Centre for Economic Policy Research (CEPR)

Ramana Nanda

Imperial College Business School; Harvard University - Entrepreneurial Management Unit

Matthew Rhodes-Kropf

Harvard Business School - Entrepreneurial Management Unit; National Bureau of Economic Research (NBER)

Savitar Sundaresan

Imperial College Business School

Date Written: January 31, 2023

Abstract

We provide novel evidence that a substantial share of venture capital investors in the U.S. use a voting model where a single partner `championing' an early stage investment is sufficient for an investment committee to do the deal, even if other partners are not as enthusiastic. Their stated reason for this voting rule is to `catch outliers'. The same VCs also tend towards more conventional `majority' or `unaninimity' rules for later stage investments. We analyze this evidence through the lense of several conventional models of information aggregation in committees, and conclude that it points to a model in which different voting partners get signals about different aspects of the project and superstar projects are the ones that excel on some dimensions even if potentially awed on others. In this case, if the distribution of investment returns is sufficiently heavy-tailed, a champions rule is optimal, while for less heavy-tailed distributions, more consensus is optimal. We then show empirically that the distribution of early stage returns have significantly heavier tails than late stage returns, validating the model. In a quantitative example, we find that a majority voting rule in early stage investing reduces the chances of finding the best investments by up to 70% relative to a `champions' model

Keywords: optimal voting rules

Suggested Citation

Malenko, Andrey and Nanda, Ramana and Rhodes-Kropf, Matthew and Sundaresan, Savitar, Catching Outliers: Committee Voting and the Limits of Consensus when Financing Innovation (January 31, 2023). Harvard Business School Entrepreneurial Management Working Paper No. 21-131, Available at SSRN: https://ssrn.com/abstract=3866854 or http://dx.doi.org/10.2139/ssrn.3866854

Andrey Malenko

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Ramana Nanda (Contact Author)

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

Harvard University - Entrepreneurial Management Unit ( email )

Boston, MA 02163
United States

HOME PAGE: http://www.people.hbs.edu/rnanda

Matthew Rhodes-Kropf

Harvard Business School - Entrepreneurial Management Unit ( email )

Soldiers Field Road
Rock Center 312
Boston, MA 02163
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Savitar Sundaresan

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

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