The Impact of Venture Capital Monitoring

We show that venture capitalists’ (VCs) on-site involvement with their portfolio companies leads to an increase in (1) innovation and (2) the likelihood of a successful exit. We rule out selection effects by exploiting an exogenous source of variation in VC involvement: the introduction of new airline routes that reduce VCs’ travel times to their existing portfolio companies. We confirm the importance of this channel by conducting a large-scale survey of VCs, of whom almost 90% indicate that direct flights increase their interaction with their portfolio companies and management, and help them better understand companies’ activities. ⇤Shai Bernstein is with Stanford University, Graduate School of Business; Xavier Giroud is with the MIT Sloan School of Management, NBER, and CEPR; Richard Townsend is with the Tuck School of Business at Dartmouth College. We are grateful to Michael Roberts (the editor), two anonymous referees, Bo Becker, José-Miguel Gaspar, Yael Hochberg, Dirk Jenter, Anna Kovner, Josh Lerner, Laura Lindsey, Holger Mueller, Francisco Pérez-González, David Robinson, Antoinette Schoar, Rob Seamans, Scott Stern, as well as seminar participants at Columbia (GSB), Dartmouth (Tuck), Duisenberg School of Finance and Tinbergen Institute, EFA (Lugano), EPFL and University of Lausanne, Economics of Entrepreneurship and Innovation Conference (Queen’s), HKUST, Harvard (HBS), LBS Private Equity Findings Symposium, MIT (Sloan), MIT Micro@Sloan Conference, NBER Entrepreneurship Meetings, Nanyang Technological University, Northeastern, Northwestern (Kellogg), Norwegian School of Economics, SFS Finance Cavalcade (Georgetown), Singapore Management University, Stanford (GSB), UCSD (Rady), UNC (KenanFlagler), University of Bergen, University of Illinois at Chicago, University of Maryland (Smith), and University of Miami School of Business for helpful comments and suggestions. It is often argued that venture capital (VC) plays an important role in promoting innovation and growth. Consistent with this belief, governments around the world have pursued a number of policies aimed at fostering VC activity (Lerner, 2009). However, there remains scarce evidence that the activities of venture capitalists actually play a causal role in stimulating the creation of innovative and successful companies. Indeed, VCs may simply select companies that are poised to innovate and succeed, even absent their involvement. In this paper, we examine whether the activities of VCs do affect portfolio company outcomes. An ideal experiment to establish the impact of VCs would be to randomly provide certain companies with VC funding and others not. Such an experiment would eliminate the selection of companies (“screening”), thus allowing us to estimate the effect of VC involvement (“monitoring”).1 Unfortunately, it is quite difficult to find a setting that convincingly approximates this experiment. That being said, another useful experiment would be to instead randomly vary VC involvement after initial investments are made. This would allow us to identify the effect of VC involvement, holding company selection fixed. In particular, if differences in outcomes for VC-backed companies are driven purely by selection, post-investment involvement of the VCs should have no effect. In this paper, we attempt to approximate this second experiment. The source of exogenous variation in VC involvement that we exploit is the introduction of new airline routes that reduce the travel time between VC firms and their existing portfolio companies. Previous work suggests that travel time reductions lower monitoring costs for firms with headquarters that are geographically separated from their production facilities (Giroud, 2013). If VC activities do matter, reductions in the cost of monitoring should translate into better portfolio company performance by allowing VCs to engage in more of these activities. To obtain direct evidence on whether VC involvement increases following reductions in travel time, we conduct a large-scale survey of VC investors. Almost 90% of the 306 survey participants agreed that they would visit a portfolio company more frequently following the introduction of a direct flight. Survey participants also agreed that the introduction of a direct flight would help them 1Kaplan and Strömberg (2001) review the screening and monitoring roles of VCs, and emphasize the difficulty of disentangling them.