Finance - Bottazzi Lecture 5b

“The Interaction between Product Market and Financing Strategy: The Role of Venture Capital” : 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION “The Interaction between Product Market and Financing Strategy: The Role of Venture Capital” Hellmann and Puri (Review of Financial Studies, 2000)

Overview : 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION Overview This study examines survey data on 149 Silicon Valley start-ups at different stages of development. Data focus on two dimensions: a. financing: VC or other (bank, own funds) b. innovation: ‘innovators’ versus ‘imitators’ Question: is there any relationship between financing and innovation? Equilibrium analysis

Slide 3: 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION Who are the innovators?

Does strategy affect the type of financing? YES! : 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION Does strategy affect the type of financing? YES!

…. Moreover innovators are faster to obtain financing than imitators : 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION …. Moreover innovators are faster to obtain financing than imitators

Does financing affect product market outcomes? : 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION Does financing affect product market outcomes?

….. and this effect is stronger for innovators: a role for VC : 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION ….. and this effect is stronger for innovators: a role for VC

What does VC provide to imitators, then? Money : 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION What does VC provide to imitators, then? Money

Assessing the contribution of Venture Capital to Innovation : 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION Kortum and Lerner (RAND Journal, 2000) Assessing the contribution of Venture Capital to Innovation

Overview : 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION Does VC contribute to make companies more innovative? YES! One dollar of VC is about 3 times as effective at creating new patents than one dollar of traditional R&D expenditure. Authors look at US patenting data from 1965 to 1992, trying to assess the contribution of VC funding to innovation through patenting. Table 1: trends in patenting, R&D (sectoral concentration) Overview

Slide 11: 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION Patenting Activity, R&D Expenditures, and Venture Capital Disbursements for US Manufacturing Industries

Slide 12: 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION Reduced form regressions Data on R&D expenditure, VC funding, and patenting in 20 sectors. Problems: patent assignment and separation VC / R&D. b captures role of VC α returnso to scale ρ substitutability between R and V Methodology

Slide 13: 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION NLS Analysis of Patent Production Function

Causality problems : 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION Causality problems Consider the following model of innovation: where N represents a shock to I and Pit= Iit εit Cost of innovating by VC is given by:

Causality problems : 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION Cost of managing the last corporate-backed innovation is where f1 is increasing while f2 is decreasing in V, v is the cost of funds to VC, and λ is the degree of opportunities for VC investments. Πit is the expected value of an innovation in industry i at t We can derive equilibrium conditions by equating marginal costs to marginal benefits: Causality problems

Causality problems : 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION Where g1 is an increasing and g2 is a decreasing function of λ Total innovative effort ↓ in v, the cost of venture funding but ↑in N. Venture funding relative to corporate finnancing ↑ in λ and ↓ in v. biased estimates if controls (year and industry) only partially capture the underlying variation in technological opportunities Use IV: dummy for pre/post 1979 Bureau of Labor Statistics defines “prudent man” rule. This corresponds to a fall in the cost of funds, v. Causality problems

IV Analysis of Linear Patent Production Function : 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION IV Analysis of Linear Patent Production Function

Slide 18: 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION Focus the analysis on the patent/innovation link: it could be that venture disbursement stimulate patenting for protection from disclosure or for ‘window dressing’ purposes. Employ a sample of 530 firms in Middlesex County in MS. Analysis tries to exploit the ‘value’ of a patent, as revealed by four measures : a. number b. citations c. renewals d. Litigation Regression analysis confirms that VC-backed firms do produce more and more valuable patents. Patenting or innovation?

Slide 19: 

8204 ENTREPRENEURSHIP, FINANCE AND INNOVATION IP Activities of VC Backed and non-VC Backed Firms