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Competition and Specialization: Evidence from Venture Capital

Christos Cabolis (), Mian Dai and Konstantinos Serfes ()

No 2014-5, School of Economics Working Paper Series from LeBow College of Business, Drexel University

Abstract: We investigate the relationship between competition and firm specialization in the venture capital (VC) market. Staged financing motivates VC firms to fund entrepreneurs in various states of maturity: startup/seed, early, growth, and so forth, and leads to stage specialization. Contrary to the conventional wisdom that competition always promotes specialization, we find an inverted-U relationship, using panel data on VC funding rounds in the U.S. between 1980 and 2006. We develop a matching model with two-sided vertical heterogeneity, bilateral bargaining and moral hazard to demonstrate that the non-monotonicity is driven by the expected utility VC firms offer to entrepreneurs, via equity stakes, where higher quality entrepreneurs (with more promising business plans) receive greater utility. Competition shifts and rotates the utility schedule, which gives rise to two opposing forces on the returns to specialization as competition intensifies. We then search for validation of the mechanism we propose and we find consistent empirical evidence.

Keywords: Venture capital market; Stage specialization; Competition; Endogenous matching (search for similar items in EconPapers)
JEL-codes: D21 L11 L14 L22 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-com and nep-ent
Date: 2014-03-01, Revised 2014-10-05
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