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Entrepreneurial Finance/Venture Capital

Paper Session

Tuesday, Jan. 5, 2021 3:45 PM - 5:45 PM (EST)

Hosted By: American Finance Association
  • Chair: Yael Hochberg, Rice University

The Evolution of CEO Compensation in Venture Capital Backed Startups

Michael Ewens
,
California Institute of Technology
Ramana Nanda
,
Harvard University
Christopher Stanton
,
Harvard University

Abstract

We use individual-level data to shed light on the evolution of founder-CEO compensation in venture capital-backed startups. We document that having a revenue-generating product is a fundamental milestone in CEOs' compensation contracts, suggesting an inflection in the firm's lifecycle from differentiation to standardization. Once the venture has achieved ``product market fit,' liquid cash compensation for founder-CEOs increases significantly in response to product and financial milestones well before acquisition or IPO. Increased cash compensation prior to a liquidity event improves the certainty equivalent of attempting entrepreneurship, but low cash compensation in the very early years can still deter entrepreneurship for some potential entrants. We characterize the types of individuals most likely to be impacted by this constraint and hence the types of ideas that are unlikely to be commercialized through VC-backed entrepreneurship.

Investor Tax Credits and Entrepreneurship: Evidence from U.S. States

Matthew Denes
,
Carnegie Mellon University
Sabrina T. Howell
,
New York University
Filippo Mezzanotti
,
Northwestern University
Xinxin Wang
,
University of California-Los Angeles
Ting Xu
,
University of Virginia

Abstract

Angel investor tax credits are used globally to spur high-growth entrepreneurship. Exploiting the staggered implementation of these tax credits in 31 U.S. states, we find that while they increase angel investment, they have no significant effect on entrepreneurial activity. Tax credits induce entry by inexperienced, local investors and are often used by insiders. A survey of 1,411 angel investors suggests that a “home run” investing approach alongside coordination and information frictions explain low take-up among experienced investors. The results contrast with evidence that direct subsidies to firms have large positive effects, raising concerns about using investor subsidies to promote entrepreneurship.

Do Venture Capitalists Stifle Competition?

Xuelin Li
,
University of Minnesota
Tong Liu
,
University of Pennsylvania
Lucian Taylor
,
University of Pennsylvania

Abstract

We find that common ownership leads VCs to stifle competition among startups, but only in limited circumstances. Our evidence is from pharmaceutical startups, where common ownership is widespread. We examine how a startup responds after seeing a competitor make progress on a related drug project. If the two startups share a common VC, the lagging startup is less likely to advance its own project and obtain VC funding, which reduces competition between the startups. These anticompetitive effects, however, are limited to concentrated product markets, technologically similar projects, early-stage projects, and VCs with larger equity stakes and less-diversified portfolios.

A Dark Side of Corporate Venture Capital

Xuan Tian
,
Tsinghua University
Kailei Ye
,
University of North Carolina-Chapel Hill

Abstract

We examine a dark side of corporate venture capital (CVC) programs. Relying on plausibly exogenous variation in passive institutional ownership generated by Russell 1000/2000 index reconstitutions, we show that firms with larger passive institutional ownership cut their CVC investment. This effect is more pronounced for firms with severer managerial agency problems. Further tests show that passive institutional investors induce firms to cut CVC investment in startups that are unrelated to the firms’ core businesses and are of low quality, and when firms have poor track record on CVC investment. By doing so, firm value increases. Our paper uncovers a previously under-explored dark side of CVC programs, their giving rise to managerial agency problems, and helps provide a more complete picture when evaluating CVC programs.
Discussant(s)
Steven Kaplan
,
University of Chicago
Shai Bernstein
,
Stanford University
Adrien Matray
,
Princeton University
Song Ma
,
Yale University
JEL Classifications
  • G2 - Financial Institutions and Services