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Competition and Specialization: Evidence from Venture Capital

Author

Listed:
  • Cabolis, Christos

    (ALBA Graduate Business School)

  • Dai, Mian

    (School of Economics LeBow College of Business Drexel University)

  • Serfes, Konstantinos

    (School of Economics 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.

Suggested Citation

  • Cabolis, Christos & Dai, Mian & Serfes, Konstantinos, 2014. "Competition and Specialization: Evidence from Venture Capital," School of Economics Working Paper Series 2014-5, LeBow College of Business, Drexel University, revised 05 Oct 2014.
    • Handle: RePEc:ris:drxlwp:2014_005
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    References listed on IDEAS

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    More about this item

    Keywords

    Venture capital market; Stage specialization; Competition; Endogenous matching;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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