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How Does Venture Capital Financing Improve Efficiency in Private Firms? A Look Beneath the Surface
June 2008
Working Paper Number:
CES-08-16
Using a unique sample from the Longitudinal Research Database (LRD) of the U.S. Census Bureau, we study several related questions regarding the efficiency gains generated by venture capital (VC) investment in private firms. First, does VC backing improve the efficiency (total factor productivity, TFP) of private firms, and are certain kinds of VCs (higher reputation versus lower reputation) better at generating such efficiency gains than others? Second, how are such efficiency gains generated: Do venture capitalists invest in more efficient firms to begin with (screening) or do they improve efficiency after investment (monitoring)? Third, how are these efficiency gains spread out over rounds subsequent to VC investment? Fourth, what are the channels through which such efficiency gains are generated: increases in product market performance (sales) or reductions in various costs (labor, materials, total production costs)? Finally, how do such efficiency gains affect the probability of a successful exit (IPO or acquisition)? Our main findings are as follows. First, the overall efficiency of VC backed firms is higher than that of non-VC backed firms. Second, this efficiency advantage of VC backed firms arises from both screening and monitoring: the efficiency of VC backed firms prior to receiving financing is higher than that of non-VC backed firms and further, the growth in efficiency subsequent to receiving VC financing is greater for such firms relative to non-VC backed firms. Third, the above increase in efficiency of VC backed firms relative to non-VC backed firms increases over the first two rounds of VC financing, and remains at the higher level till exit. Fourth, while the TFP of firms prior to VC financing is lower for higher reputation VC backed firms, the increase in TFP subsequent to financing is significantly higher for the former firms, consistent with higher reputation VCs having greater monitoring ability. Fifth, the efficiency gains generated by VC backing arise primarily from improvement in product market performance (sales); however for higher reputation VCs, the additional efficiency gains arise from both an additional improvement in product market performance as well as from reductions in various input costs. Finally, both the level of TFP of VC backed firms prior to receiving financing and the growth in TFP subsequent to VC financing positively affect the probability of a successful exit (IPO or acquisition).
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On the Lifecycle Dynamics of Venture-Capital- and Non-Venture-Capital-Financed Firms
May 2008
Working Paper Number:
CES-08-13
We use a new data set that tracks U.S. firms from their birth over two decades to understand the life cycle dynamics and outcomes (both successes and failures) of VC- and non-VC financed firms. We first ask to what market-wide and firm-level characteristics venture capitalists respond in choosing to make their investments and how this differs for firms financed solely by non-VC sources of entrepreneurial capital. We then ask what are the eventual differences in outcomes for firms that receive VC financing relative to non-VC-financed firms. Our findings suggest that VCs follow public market signals similar to other investors and typically invest largely in young firms, with potential for large scale being an important criterion. The main way that VC financed firms differ from matched non-VC financed firms, is they demonstrate remarkably larger scale both for successful and failed firms, at every point of the firms' life cycle. They grow more rapidly, but we see little difference in profitability measures at times of exit. We further examine a number of hypotheses relating to VC-financed firms' failure. We find that VC-financed firms' cumulative failure rates are lower than non-VC-financed firms but the story is nuanced. VC appears initially 'patient' in that VC-financed firms are less likely to fail in the first five years but conditional on surviving past this point become more likely to fail relative to non-VC-financed firms. We perform a number of robustness checks and find that VC does not appear to have more stringent survival thresholds nor do VC-financed firm failures appear to be disguised as acquisitions nor do particular kinds of VC firms seem to be driving our results. Overall, our analysis supports the view that VC is 'patient' capital relative to other non-VC sources of entrepreneurial capital in the early part of firms' lifecycles and that an important criterion for receiving VC investment is potential for large scale, rather than level of profitability, prior to exit.
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The Efficiency of Internal Capital Markets: Evidence from the Annual Capital Expenditure Survey
April 2008
Working Paper Number:
CES-08-08
We empirically examine whether greater firm diversity results in the inefficient allocation of capital. Using both COMPUSTAT and the Annual Capital Expenditure Survey (ACES) we find firm diversity to be negatively related to the efficiency of investment. However once we distinguish between capital expenditure for structures and equipment, we find that while firms do inefficiently allocate capital for equipment, they efficiently allocate capital for structures. These results suggest that when the decision will have long-lasting repercussions, headquarters will, more often than not, make the correct choice.
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Financial Intermediation and Late Development: The Case of Meiji Japan, 1868 to 1912
January 2008
Working Paper Number:
CES-08-01
Was nineteenth century Japan an example of finance-led growth? Using a new panel dataset of startup firms from the Meiji Period (1868-1912), I test whether financial sector development influenced the emergence of modern industries. Results from multiple econometric models suggest that increased financial intermediation, particularly from banks, is associated with greater firm establishment. This corresponds with the theory of late development that industrialization requires intermediaries to mobilize and allocate financing. The effect is pronounced in the second half of the period and for heavy industries, which may be due to improved institutions and larger capital requirements, respectively.
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Democratizing Entry: Banking Deregulations, Financing Constraints, and Entrepreneurship
December 2007
Working Paper Number:
CES-07-33
We study how US branch-banking deregulations affected the entry and exit of firms in the non-financial sector using establishment-level data from the US Census Bureau's Longitudinal Business Database. The comprehensive micro-data allow us to study how the entry rate, the distribution of entry sizes, and survival rates for firms responded to changes in banking competition. We also distinguish the relative effect of the policy reforms on the entry of startups versus facility expansions by existing firms. We find that the deregulations reduced financing constraints, particularly among small startups, and improved ex ante allocative efficiency across the entire firm-size distribution. However, the US deregulations also led to a dramatic increase in 'churning' at the lower end of the size distribution, where new startups fail within the first three years following entry. This churning emphasizes a new mechanism through which financial sector reforms impact product markets. It is not exclusively better ex ante allocation of capital to qualified projects that causes creative destruction; rather banking deregulations can also 'democratize' entry by allowing many more startups to be founded. The vast majority of these new entrants fail along the way, but a few survive ex post to displace incumbents.
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The Adoption and Diffusion of Organizational Innovation: Evidence for the U.S. Economy
June 2007
Working Paper Number:
CES-07-18
Using a unique longitudinal representative survey of both manufacturing and nonmanufacturing businesses in the United States during the 1990's, I examine the incidence and intensity of organizational innovation and the factors associated with investments in organizational innovation. Past profits tend to be positively associated with organizational innovation. Employers with a more external focus and broader networks to learn about best practices (as proxied by exports, benchmarking, and being part of a multi-establishment firm) are more likely to invest in organizational innovation. Investments in human capital, information technology, R&D, and physical capital appear to be complementary with investments in organizational innovation. In addition, nonunionized manufacturing plants are more likely to have invested more broadly and intensely in organizational innovation.
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A General Inter-Industry Relatedness Index
December 2006
Working Paper Number:
CES-06-31
Firm growth and expansion is widely believed to be guided by the desire to leverage existing resources. But which resources? The answer depends largely on context.the peculiarities of industries, firms, technologies, production, customers, and a host of other dimensions. This fact makes pointing to any particular set of resources as the source of expansion decisions potentially problematic and makes more difficult tests of theories such as the resource-based view of the firm. This paper tackles the problem by developing a general inter-industry relatedness index that can be usefully applied across industry and firm contexts. The index harnesses the relatedness information embedded in the multi-product organization and diversification decisions of every firm in the US manufacturing economy. The index is general in that it implicitly varies the underlying resources upon which expansion proceeds with the industries in question and provides a percentile relatedness rank for every possible pair of fourdigit SIC manufacturing industries. The general index is tested for predictive validity and found to perform as expected. Applications of the index in strategy research are suggested.
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Industry Learning Environments and the Heterogeneity of Firm Performance
December 2006
Working Paper Number:
CES-06-29
This paper characterizes inter-industry heterogeneity in rates of learning-by-doing and examines how industry learning rates are connected with firm performance. Using data from the Census Bureau and Compustat, we measure the industry learning rate as the coefficient on cumulative output in a production function. We find that learning rates vary considerably among industries and are higher in industries with greater R&D, advertising, and capital intensity. More importantly, we find that higher rates of learning are associated with wider dispersion of Tobin's q and profitability among firms in the industry. Together, these findings suggest that learning intensity represents an important characteristic of the industry environment.
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Cementing Relationships: Vertical Integration, Foreclosure, Productivity, and Prices
July 2006
Working Paper Number:
CES-06-21
This paper looks at the reasons for and results of vertical integration, with specific regard to its possible effects on market power as proposed in the theoretical literature on foreclosure. It uses a rich data set on producers in the cement and ready-mixed concrete industries over a 34- year period to perform a detailed case study. There is little evidence that foreclosure effects are quantitatively important in these industries. Instead, prices fall, quantities rise, and entry rates remain unchanged when markets become more integrated. We suggest an alternative mechanism that is consistent with these patterns and provide additional evidence in support of it: namely, that higher productivity producers are more likely to vertically integrate, and as has been documented elsewhere, are also larger, more likely to grow and survive, and charge lower prices. We explore possible sources of vertically integrated producers' productivity advantage and find that the advantage is tied to firm size, possibly in part through improved logistics coordination, but not to several other possible explanations.
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Plant Turnover and Demand Fluctuations in the Ready-Mix Concrete Industry
March 2006
Working Paper Number:
CES-06-08
Fluctuations in demand cause some plants to exit a market and other to enter. Would eliminating these 'uctuations reduce plant turnover? A structural model of entry and exit in concentrated markets is estimated for the ready-mix concrete industry, using plant level data from the U.S. Census. The Nested Pseudo-Likelihood algorithm is used to 'nd parameters which rationalize behavior of 'rms involved in repeated competition. Due to high sunk costs, turnover rates would only be reduced by 3% by eliminating demand 'uctuations at the county level, saving around 20 million dollars a year in scrapped capital. However, demand 'uctuations blunt 'rms'incentive to invest, reducing the number of large plants by more than 50%.
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