INSTITUTIONAL INFLUENCES ON CORPORATE VENTURE CAPITAL IN EMERGING MARKETS
The inter-related effect of liability of foreignness and syndication on CVC Portfolio Companies
MSc Thesis Business Administration - International Management
Name: Roelof Gjaltema Student number: 11111127 Lecturer: Dr. Vittoria Scalera Date: 27/01/2017
University of Amsterdam (UVA) Keywords
Corporate Venture Capital; Emerging Market; Institutions; Venture Capital Syndication; Syndicate Composition; Government-sponsored Venture Capital; Liabilities and Assets of Foreignness.
STATEMENT OF ORIGINALITY
This document is written by Student Roelof Gjaltema who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
ABSTRACT
China and India have become the second and fourth largest Venture Capital (VC) markets in less than two decades. Within this industry, Corporate Venture Capital (CVC) has become an important catalyst of entrepreneurial activity, attracting large sums of investments from both domestic and foreign incumbent firms. While many studies have discussed cross-border VC, very few have demonstrated an understanding of CVC practice in Emerging Markets (EMs). This study investigates whether performance of EM Portfolio Companies (PCs) differs between PCs that are backed by foreign CVCs and those funded by domestic CVCs. This paper further incorporates research on the effect of CVC syndication and syndication composition on PC success. Examining the period between 2002-2011, the analysis shows that foreign CVCs are subject to Liability of Foreignness (LOF) and that PCs backed by domestic CVC perform better. Syndication has a strong positive effect on PC performance and moderates the relation between the foreign CVC and PC success. The results only show partial support for the value of partnering with a local VC by the foreign CVC. The findings further indicate that co-investment by the domestic CVC with a foreign VC does not significantly alter PC’s likelihood of success. Partnering with Government-sponsored Venture Capitalists (GVCs) however does substantially increase PC likelihood of success in the case of foreign CVC backed PCs. Such partnerships do not have any implications for PCs backed by domestic CVCs. This study discusses important implications for both PC- and CVC executives and policy makers in EMs.
TABLE OF CONTENT
1. INTRODUCTION ... 7
2. THEORETICAL FRAME WORK ... 11
2.1 Literature Review ... 11
2.1.1 (Corporate) Venture Capital ... 11
2.1.2 (Corporate) Venture Capital Syndication ... 14
2.1.3 Emerging Market Institutions ... 16
2.1.4 Government-sponsored Venture Capital ... 18
2.1.5 CVC Liabilities and Assets of Foreignness ... 20
2.2 Research Gap ... 22
2.3 Hypotheses Development ... 23
2.3.1 The inter-related effect of LOF and syndication on EM CVC ... 23
2.3.2 Syndication in India and China: Valuing Domestic and Foreign partners ... 26
2.3.3 Co-investment with Government, overcoming institutional weaknesses. ... 28
2.4 Conceptual Model ... 30
3. METHODOLOGY ... 31
3.1 Sample ... 31
3.2 Database ... 32
3.3 Data collection procedure ... 33
3.4 Description of Variables ... 34
3.4.1 Dependent variable ... 34
3.4.2 Independent and moderating variables ... 34
3.4.3 Control Variables ... 35
3.5 Method of Analysis ... 39
4. RESULTS ... 40
4.1 Sample characteristics ... 40
4.1.1 Total sample descriptive statistics and correlations ... 40
4.1.2 Subsample descriptive statistics and correlations ... 43
4.3 Regression ... 46
4.3.1 Model (1) Results ... 46
4.3.2 Model (2) domestic subsample results ... 48
4.3.3 Model (2) foreign subsample results ... 49
5. DISCUSSION ... 52
5.2 Implications for managers and policy makers. ... 56
5.3 Limitations and Recommendations for future research ... 58
6. CONCLUSION ... 60
7. REFERENCES ... 62
8. APPENDIX ... 67
LIST OF FIGURES AND TABLES
Figure 1 Conceptual model
Table 1 All variables: their description, operationalization and possible outcome Table 2 Descriptive statistics and correlations total sample
Table 3 Descriptive statistics and correlations foreign subsample Table 4 Descriptive statistics and correlations domestic subsample Table 5 Results of Binary Logistic Regressions
ACKNOWLEDGEMENTS
I would like to express a special word of gratitude towards Dr. Vittoria Scalera. Her involvement and valuable feedback sessions have motivated me a lot during the process of putting together this Master Thesis. In addition, I would particularly like to thank my girlfriend and parents as they have always supported me in whatever endeavor that I have chosen to undertake.
1. INTRODUCTION
In May 2016 China-based Lenovo, the world’s largest computer fabricant, launched its second Corporate Venture Capital (CVC) fund. Investing a total of US$ 500 million into its venture arm, Lenovo intends to further invest in early-stage ventures, aiming to enhance its own expertise in cloud computing and artificial intelligence (Li, 2016). Similar CVC entities have previously been established by many other firms, pre-dominantly by those that originate from Developed Economies (DMs). The size of CVC in these mostly Anglo-Saxon markets, inspired a range of authors to research the phenomenon (e.g. Chesbrough, 2000; 2013; Dushnitsky and Lenox, 2005; Yang, Narayanan and Zahra, 2009). They often used the lens of organizational learning to explain CVC behaviour (Yang et al., 2009), framing CVC as a means to access technology, enhancing the investing firm’s own internal technological developments (Chesbrough, 2013).
As Emerging Markets (EMs) like China or India begin to mature, these markets face fundamental transformation of their institutions (Peng, 2003). This transition of EMs is often characterized by increasing market orientation as entrepreneurship plays a key role (Ahlstrom and Bruton, 2006). As a consequence, this has led to a dramatic increase of EM Venture Capital (VC). In 2014, the share of Chinese VC relative to the global total doubled, as its proportion went from an average 9% between 2006 and 2013 to a total of 18% in 2014 (Ernst and Young, 2015), making it the second largest VC market in the world (Worldbank, 2016). Similarly, the Indian VC market went from being almost non-existent in 2000, to being the fifth-largest market now (Ernst & Young, 2015). But whilst VCs across the globe share similar beliefs on how to invest (Bruton, Ahsltrom and Yeh, 2004) and institutions are subject to isomorphism (Dimaggio and Powell, 1983), institutional differences remain profound and do impact businesses (Peng, 2003). VCs, however, actually depend on stable institutional environments that safeguard their investments (Ahlstrom and Bruton, 2006). Moreover, they
prefer markets that inhibit efficient corporate control, which caters for systems with minimal corruption (Wright and Robbie, 1998). In turn, this reduces the VCs’ risk as it better enables Portfolio Companies’ (PCs) successful exit1 (here after, PC success). As, China and India are renowned for their volatility, unpredictability and un-codified institutional environments (Peng, 2000) this thus poses potential liabilities for the successful execution of VC practice (Ahlstrom and Bruton, 2006).
Next to these challenges, foreign firms also face Liability of Foreignness (LOF) when they operate overseas (Zaheer, 1995). Foreign VCs are at a disadvantage due to information asymmetries and monitoring problems caused by cultural and geographical distances (Dai, Jo and Kassichieh., 2012; Lu and Hwang, 2010). Foreign VCs may lack legitimacy and reputation within the local market (Gu and Lu, 2014; Nahata, Haziraka and Tandon, 2014). To the benefit of foreign VCs however, is that they may benefit from a strong brand image, the international VC’s ability to leverage its network and greater pools of equity and experience (Dai et al, 2012; Lu and Hwang, 2010). Such benefits may be referred to as Assets of Foreignness (AOF) (Sethi and Judge, 2009). In addition, VCs have the possibility to syndicate their investments (Lerner, 1994) which may help mitigate LOF and reduce risk (Lu and Hwang, 2010). In the EM setting, syndication has indeed proven to substitute for inefficient markets and weaker rule of law (Ahlstrom and Bruton, 2006; Peng, 2003). The composition of such syndicates impacts PC success (Maula, Autio and Murray, 2005). Joint investment of Independent Venture Capitalists (IVCs) with CVCs and so-called Government-sponsored VCs (GVCs) may contribute to PC performance (Maula et al., 2005) and
1 In the bulk of the VC literature, the exit of the PC is labeled successful when the PC either goes for an IPO or is
acquired via M&A. The literature review of this study provides a further contemplation on the concept of PC success. In the remainder of this study, PC successful exit (thus being an IPO or Trade Sale) will be referred to as PC success.
partnerships between international and local VCs may also increase PC likelihood of success (Dai et al., 2012, Nahata et al., 2014).
But while IB literature shows that inclusion into local business groups and government affiliation may drastically improve the business outlook of corporations and VCs in China and India (Hoskisson, Eden, Lau, and Wright, 2000), the existing literature lacks an understanding of how this is true for CVC. Thus, less is known about how LOF effects CVCs in EMs. Similarly, the effect of syndication on both foreign and domestic CVCs has not yet been tested. Finally, to my knowledge, the literature is non-existent in regards to the specific composition of CVC-led syndicates in EM. Further empirical research would thus enhance our understanding of how CVCs perform in India and China. The composition of the VC industry enables me to test these effects. First, CVCs’ connection to local business groups may be tested through flagging syndication with local VCs. Second, in researching the effect of government connections, a similar approach may be followed by examining CVC syndicates for their inclusion of GVCs. The understanding of how CVC performance is affected by the concepts of LOF, syndication and syndicate composition is valuable not only to academics but also to executives and policy makers. Consequently, I have set out to answer the following research question:
Should Emerging Market entrepreneurs prefer foreign or domestic CVC funding and how does the occurrence- and composition of syndication effect this consideration?
The sample of this study contains all Indian and Chinese PCs that received at least one CVC investment between 2002-2011. I collected this data from the Thomson One Venture Xpert Database. The study incorporated 2100 investments made between 2002-2011, covering a total of 578 PCs and 551 CVC firms.
My study contributes to the existing literature in several ways. First, I show that PCs that are funded by foreign CVCs instead of domestic CVCs face significantly lower
likelihoods of success. As such, this study adds to existing research on VC internationalization (Dai et al., 2012; Lu and Hwang, 2008; Wang, 2016). Second I show that syndication has a very substantial and positive effect on the odds of PC success. This effect is even greater for the PCs that are backed by foreign CVCs. Thus, this study shows that syndication moderates the effects of LOF. Consequently, my paper contributes to the already substantial amount of literature on VC syndication (e.g. Hochberg, Ljungqvist, and Lu, 2007; Lerner, 1994). Third, the results show that co-investment of a domestic CVC with a foreign VC does not significantly alter the PCs odds of success. At the same time, this study presents some support that foreign CVCs should consider to partner with local VCs. Combined, this study presents the first insights in how such foreign and local partnering effects CVC investments, thus adding to the work of Dai et al. (2012) and Nahata et al. (2014). I also show that those PCs that are backed by foreign CVC face substantially higher likelihoods of success when they receive investment by GVCs. These findings partially differ from what previous research (Lerner, 2009; Brander et al., 2010 would suggest. Finally, this study contributes to our understanding of CVC practice in EMs and has important managerial and regulatory implications.
The remainder of this paper is organized as follows. In order to lay out the theoretical foundation of this study, I discuss the previously written literature. After doing so, I conclude with the presentation of a research gap and the research hypotheses. After that, the methodology is discussed. Next, I present the results in which the hypothesis-testing is presented. Finally, I round off with a discussion, implications for managers and policy makers, a limitations and recommendations for future research chapter and a conclusion.
2. THEORETICAL FRAME WORK
In the following chapter, I reflect and contrast previously published literature about VC in general, CVC, CVC syndication, EM Institutions and the IB concept of Foreignness. On the basis of the literature, I present the research gap for this study, followed by a set of hypotheses.
2.1 Literature Review
This chapter deals with a set of specific questions that should be answered and understood in order to have a sufficient understanding of the concepts related to this study’s hypotheses. The first section answers the questions ‘’What is VC?’’ and ‘’How does CVC distinguishes itself from other forms of VC?’. Second, I discuss the concept of CVC syndication and provide an answer as to ‘’Why do CVCs co-investment?’’. After that, I contemplate on the concept of institutions and answer the questions of ‘’How does the institutional environment of China and India look like?’’, and more precise, ‘’Which are the institutional concepts within this environment that are relevant to CVC practice?’’ and ‘’What kind of role do governments play in the VC market’’?. Finally, I provide an answer to the question ‘’How do LOF and AOF affect CVC and their PCs?’’.
2.1.1 (Corporate) Venture Capital
VC organizations collect funds from institutions and individuals to invest in early-stage companies that have high potential but also high risk (Sahlman, 1990). As such, VC provides capital to firms that might otherwise have difficulty attracting finance (Gompers and Lerner, 2001). In turn, such VC investment is usually rewarded for an equity stake in the new business (Bruton et al., 2004). The concept of VC originally came to existence in the U.S.. Between 1946 and 1977 U.S. VC activity maximally amounted a few hundred million dollars per year, whilst usually being much less. From 1979 however, a series of amendments made by lawmakers allowed for pension funds to invest in much riskier assets. As such, pension
fund managers were no longer limited from investing in young firms and soon total VC investment amounted to Billions of dollars (Kortumand Lerner, 2000). Subsequently, VC then spread to countries such as the U.K., Germany, Israel and the Netherlands which also explains why VC academia have had a pre-dominantly western focus until very recent (Ahlstrom and Bruton, 2006).
The most important distinction within VC is that between IVCs and CVCs (Maula et al., 2005). IVCs would usually be described as ‘’classic’’ VCs and best fit the definition of Sahlman (1990), defining VC as limited partnerships that are independent of a corporation and in which the venture capitalists act as general partners and external investors as limited partners. IVCs are in ‘’the game’’ for financial returns only and seek to benefit from lucrative PC exits via IPO or M&A activity (Maula and Murray, 2001). CVC is certainly not a synonym of ‘’Classic’’ VC nor is it independent from a corporation (Chesbrough, 2002, Maula et al., 2005). Despite its dependence from a corporation however, CVC is clearly distinct from general corporate venturing as the latter concerns a broader scope and also includes inter-firm investments and corporate joint ventures (Dushnitsky and Lenox, 2006; Thornhill and Amit, 2001). In essence, CVC is best described as equity investments flowing from the venture arm of an incumbent firm, targeting young and entrepreneurial companies (Dushnitsky and Lenox, 2005A ; Gompers and Lerner, 2000). Other than for IVCs, CVCs’ goal is often much more than solely that of financial gains. Besides achieving financial objectives, the incumbent firms use it to serve a range of strategic objectives (Maula and Murray, 2001). CVC is used as a means to access technology, in turn enhancing the investing firm’s own internal technological developments and innovation (Chesbrough, 2013; Dushnitsky and Lenox, 2005b).
Apart from the differing objectives, CVCs and IVCs also differ in terms of their contribution towards commercial success of the PC (Gompers and Lerner, 2000). Next to the
provision of finance, Maula et al. (2005) found that IVCs assist with additional financial arrangements, the recruitment of key staff-members and support in strategic decision making. CVCs, on the other hand, provide the PC with preferential access to distribution channels, production facilities and insight into private corporate information (Maula and Murray, 2001). CVCs appear to be more effective in advice on technologies employed by PCs, but also provide more knowledge-based learning benefits and are better able to assist in attracting foreign customers (Maula et. al, 2005).
Despite the contribution that CVCs may potentially make towards PC success, the history of CVC activity is marked by periods of rapid growth and sharp decline (Dushnitsky and Lenox, 2006). Such whimsical nature is caused by deeper and more structural shortcomings that CVCs face. Most salient is the fear that many PCs have of expropriation by the CVC firm, ultimately preventing a successful investor-investee relationship (Chesbrough, 2000; Ernst et al., 2005). Moreover, and in this respect CVC does yet again differ from IVC, those funds operated by corporations may not provide similar employee incentives as funds operated by IVCs (Maula and Murray, 2001). This disparity is partially caused by the fact that CVC funds have to battle with other business units over scarce firm resources (Siegel, Siegel, MacMillan, 1988; Sykes, 1986). Finally, as CVC funds are not independent – which is the case for IVCs – the former are sensitive to a corporation’s economic downturn or changes in the mother-firm’s top management teams (Dushnitsky and Shaver, 2009). This may cause the firm’s priorities to shift; which in the worst case, may mean that the new firm’s management chooses to disrupt or abort the support towards the CVC (Block and MacMillan, 1993; Dushnitsky and Shaver, 2009).
Despite such potential CVC deficiencies, CVC does have the potential to add value to PCs (Chesbrough, 2000). Indeed, Maula and Murray (2001) found that those PCs that were co-invested in by CVCs were given higher IPO valuations than those ventures that had only
received ‘’classic’’ VC funding. As Maula et al. (2005) put it correctly; ‘’CVCs and IVCs have different but strongly complementary value-added profiles – each is of significant use to the recipient PC’’ (p. 17). Naturally, in search of synergies both investors and investees are likely to opt for co-investment.
2.1.2 (Corporate) Venture Capital Syndication
Though prevalent in a lot of business-related academics, the concept of networking has received substantial attention in VC Literature. In the context of VC, networking between investors occurs when two or more firms take an equity stake in a PC (Tian, 2011). This practice of co-investing is referred to as VC syndication. Tian (2011) showed that for those 30,000 entrepreneurial companies that did receive VC funding between 1980 and 2005, roughly 70% did so from two or more VC investors. In search of complementarities, such syndicates may be made up of similar or different types of investors; CVCs may choose to co-invest with other CVCs, but also with other co-investor types such as IVCs or GVCs (Maula et al., 2005).
In the literature, two definitions of what classifies as a VC syndicate have appeared. The more strict definition of syndication only considers co-investment of two or more investors in the same round as syndication. As a result, authors following this definition (e.g. Tian, 2011) classify PCs as individual backed PCs when they were funded by only one investor per round but by multiple investors over all rounds. The second, less strict definition of syndication, assumes that relationships between VCs are built through interaction in PC board meetings and thus describes a PC as ‘’syndicate-backed’’ when different investors have funded the PC across- rather than in the same round (Hochberg et al., 2007). From the PC’s perspective, the latter definition of syndication may perhaps be most relevant as the VCs of all investment rounds are going to have to work together. The information and assets that they are willing to share is ultimately what is going to either benefit or harm the PC. A broad range
of VC literature (Hochberg et al., 2007; Lerner, 1994; Sahlman, 1990; Tian, 2011) does indeed highlight how multiple syndicate-members may provide heterogeneous skills, different kinds of information, industry expertise and relevant networks to the benefit of PCs. Ultimately, this may lead to higher exit valuations for the PC, which subsequently leads to higher returns for the investors.
Although syndication is thus usually considered to be beneficial to corporations, others have also found downsides. Anokhin et al. (2011) found that especially in the case of CVC, co-investment and co-supervision of PCs may also work counterproductive. Indeed, through having a seat on a PC’s board, CVCs may benefit from the exchange of valuable information and gain from know-how of co-investors. But, as the mother firm is often active in the same- or affiliated industries, such co-investors may be hesitant to work productively together with the CVC as they fear that the know-how of the PC is infringed for the good of the CVC’s mother firm. At the same time, CVCs may be reluctant to share their valuable information with a PC that receives funds from multiple investors as the CVC wants to prevent outflows of its mother firm’s tacit knowledge. Ultimately, such behavior may damage investor co-operation and diminish the PC’s chances of success (Anokhin et al., 2011; Tian, 2011).
When CVCs do consider to syndicate, they will have to ask themselves a set of important questions. Contemplations such as; how well is my valuable information protected through patent right protection? which investor types do I best consider? is this environment one in which it is likely that my PCs will successfully exit? will have to be considered. Such questions are important to VCs in any type of setting, but are likely to be even more salient in the institutional context of EMs (Ahlstrom and Bruton, 2001; 2006; Bruton, Ahlstrom and Puky, 2009 ).
2.1.3 Emerging Market Institutions
Prior to a further elaboration on the institutional environment of China and India, I believe a brief review on institutional theory is necessary. North (1991) defined institutions as ‘’humanly devised constraints that structure political, economic and social interactions’’ (p. 97). Such institutions may be classified as formal or informal, while both determine transaction and production costs, consequently impacting businesses (North, 1991). Informal institutions are those institutions that have evolved over time and may concern sanctions, taboos, customs, traditions and codes of conduct (North, 1990). Formal institutions are humanly devised constraints and may concern constitutions, laws and property rights. Williamson (2000) further contributed to institutional theory by structuring the institutional environment, distinguishing between four institutional levels. Subsequently, these four levels consider the informal institutions; formal institutions; governance systems; and interactions between actors, allocation of resources and employment. These levels are interdependent and influence each other.
Level one concerns ‘’embeddedness’’. This level is linked to informal institutions and concerns deep-rooted institutions linked to culture. In the EM context, specific and relevant examples of such informal traditions are the Chinese concepts of ‘’Guanxi’’ and ‘’Ganqing’’ (Fan, 2007; Gu, Hung and Tse, 2008) or the Indian concept of ‘’Jugaad’’ (Khanna and Palepu, 2000). ‘’Guanxi’’, for instance, originates from deeply rooted Chinese Confucianism traditions and is concerned with the idea that individuals should belong to a hierarchy or group, thus emphasizing the importance of networks (Fan, 2007). In business, this means that prior to establishing a corporate relationship, a personal relationship has to be build. In turn, such relationships may help circumvent those formal institutions, or the absence of such, that make doing business less efficient (Gu et al., 2008). Stemming from similar roots, ‘’Ganqing’’ and ‘’Jugaad’’, emphasize not losing face whilst maintaining good relations and
back the idea that it is praise-worthy to establish long-term relationships between businesses and their clients (Fan, 2007; Khan, Zolkiewski and Murphy, 2016). India and China are viewed as collectivist countries. According to Hofstede, Hofstede and Minkov (2010), India’s score on Individualism, for instance, is almost half that of the U.S. and the U.K2. Thus, the main take-away of India and China’s level one institutions should be that long-term relationships and collectivism enjoys much higher esteem than short-term gains and individualism.
Williamson’s (2000) second institutional level concerns formal institutions and relates to the regulatory level. Such formal institutions concern market regulations, government policies and accounting standards. Formal institutional voids may originate from a range of aspects; weak property rights protection, poor commercial law enforcement, immature factor markets and an unclear litigation system (Williamson, 2000). Nahata et al. (2014) argued that when institutional voids are absent and strong formal institutions are in place, this positively impacts VC activity. The absence of such formal institutional voids makes DM institutions almost ‘’invisible’’ and their markets run smoothly (Peng et al., 2008). In EMs however, financial and commercial rules are often less developed (Luo and Tung, 2007). When such rules are actually present, enforcement is often poor (Backman, 2001). EMs are known for their inadequate disclosure, weak corporate governance and lack of control. At the same time, intermediaries such as banks, mutual funds and VCs have yet to become matured (Khanna and Palepu, 2000). While India has a democratically elected government, corruption and ambiguous rules and laws have a profound impact on businesses (IPRI, 2016; Khanna and Palepu, 2000). In China’s case, despite its transition to a more liberal economy, firms have to understand that China remains a one party-state in which all power remains at the side of the
2 India’s score on Individualism is 48. That of the United States and the U.K. respectively 91 and 89 (Hofstede,
communist party (Gu et al., 2008). Fan (2007) even argues that the Chinese business environment is more complex today than it was before the market reforms. In these economies that are characterized by market inefficiencies, the organizational form of business groups has prevailed (Guillen, 2000; Yiu, Bruton and Lu, 2005) As a result, India and China are usually described as relationship-based markets (Sanyal and Guvenli, 2000; Peng et al., 2008). Within this environment businesses should pursuit strong relations with the government in order to substitute for the absence of regulations and to avoid red tape (Sanyal and Guvenli, 2000; Simon, 1982).
2.1.4 Government-sponsored Venture Capital
There is a tremendous amount of literature that contemplates on how corporations may benefit from strong relations with the government in EMs (e.g. Backman, 2001; Chen, 2001; Wright et al., 2002). Fan (2007) indeed found that constructive relations with the government have a positive effect on business performance. Still, only very little has been written on how co-investment with the government may benefit VCs. The latter is slightly remarkable though perhaps not unexplainable. On the one hand it is no longer uncommon for governments to initiate GVCs whilst, on the other hand, this is only a very recent phenomenon (Brander, Egan and Hellmann, 2010). GVCs are funds that may be endorsed by local, regional and national governments to support entrepreneurial activity (Venture Xpert Thomson One, 2016). Such government commitment to VC may be expressed through forgone taxes, outright subsidies, preferential regulation and public provision of investment capital (Brander et al., 2015).
Those three sources that did specifically discuss the topic and were most cited (Brander et al., 2010; Brander et al., 2015; Lerner, 2009) discussed the topic in respectively the Canadian setting and in a global setting. In general, I would argue that these studies did not put forward the results that one would expect based on for instance Fan (2007) and Sanyal and Guvenli’s (2000) findings. In the first of their two studies, Brander et al. (2010) found
that solely GVC funded PCs actually performed much worse than those that were funded by IVCs. In line with Lerner (2009), they further expressed serious doubts on the desirability of GVC intervention in the western VC market due to crowding out effects it may have on IVCs and less effective PC treatments. Lerner (2009) even went further and expressed outright concern that government activity in VC markets may be associated with problems originating from bureaucratic inefficiency and political pressures. It is in this line, that the study of Brander et al. (2015) pointed out that GVC investment in the U.S. had a significant and negative effect on PC success. However, no such effect were found for Europe and East Asia. Brander et al. ‘s (2015) study did show that co-investment by IVCs and GVCs increased the total investment the PC obtained, subsequently increasing the likelihood of PC success. I would therefore argue that Brander et al’s (2015) findings are similar to what Maula et al. (2005) found to be true in terms of the complementarity between CVC and IVC. However, Brander et al. (2015) emphasize that they only found ‘’some support’’ for the exit hypothesis. After simply controlling for the effect of the additional amount of investment3, IVC co-investment with GVCs was no longer significantly related to PC success in most of the countries observed.
Notwithstanding the value of their studies, both Brander et al. (2010) and Brander et al. (2015) do not take into account whether the co-investing IVC is foreign or domestic. However, GVC co-investment may be particularly important for foreign firms as this may address difficulties the firm experiences in the overseas market and aid the firm in building a network, preventing hostility from domestic firms and interested groups (Sanyal and Guvenli, 2000). To summarize, traditional IB literature would predict a beneficial role for GVC co-investment by CVCs, but the existing literature on GVC paints a mixed picture.
3 Brander et al. (2014) refer to this as investment additionallity, which is simply caused by the additional funds
2.1.5 CVC Liabilities and Assets of Foreignness
While start-ups face liability of newness in any case (Stinchcombe, 1965), those operating in EMs thus face additional risks due to the unpredictable and volatile institutional environment that they find themselves in (Ahlstrom and Bruton, 2006). Nahata et al. (2014), however, did find that the negative effect of weak formal institutions is moderated by high scores in uncertainty avoidance and collectivism (Hofstede et al., 2010). Foreign CVCs, however, may find themselves in a position in which they have to deal with the unpredictability and ambiguity of the EMs, whilst simultaneously not being able to benefit from the moderating effect that originates from collectivistic cultural aspects. In the context of the Multi-National Enterprise (MNE), such uncertainties and unfamiliarity with the local context is usually referred to as LOF (Buckley and Casson, 1976; Dunning, 1977; Zaheer 1995). Subsequently, IB authors argue that to overcome LOF, MNEs should equip their subsidiaries with skills that they have learned elsewhere (Hennart, 1982). Today, such IB literature is often used to explain the behaviour of foreign firms in the Indian and Chinese markets, and while the CVC-PC relation may differ from the MNE-Subsidiary relationship, many parallels exist.
Despite the many parallels with MNE literature, it is recent that authors have begun to research the effects of LOF on VC. Although Bruton and Ahlstrom (2003) made an effort in alienating the differences that exist between the Chinese and Western VC market, Hu and Hwang (2010) were the first to explicitly relate LOF to VC performance4. They found that LOF affected the VC investment decision process, describing how International VCs received less unsolicited deals from local networks. Indeed,cultural differences influence VC success, as the unfamiliar environment and lacking local awareness amplifies the already severe agency problems VCs face (Nahata et al., 2014). Nevertheless, the empirical findings on how
4
cultural distance impacts PC success are mixed. Dai et al. (20125) findings, more or less along the line of traditional IB literature, pointed out that increased cultural distance had a negative effect on PC success. Rather surprisingly however, Nahata et al. (20146) found that an increasing cultural distance7 between the VC and the PC, actually enhances the likelihood of PC success. The reasoning as to what causes this remarkable result is that these VCs expect additional challenges in foreign markets. Consequently, they perform much more rigorous screening before making the investment, therewith increasing the likelihood of PC success (Nahata et al., 2014).
On the other side of the spectrum, PCs may find foreign VCs attractive due to their home-grown strengths (Dai et al., 2012). Foreign firms mays benefit from AOF and Assets of Multi-Nationality (AOM) (Sethi and Judge, 2009), such as a strong brand image and the CVC’s ability to leverage its international network (Dai et al., 2012; Gu and Lu, 2014). Furthermore, foreign VCs are at an advantage over EM VCs in terms of their size and experience (Dai et al., 2012; Nahata et al., 2014). Finally, foreign VCs may alleviate the effects of geographical and cultural distance through co-investing with local partners, in turn mitigating LOF (Hu and Hwang, 2010). In effect, PCs that receive local VC investment next to foreign VC funding were found to be 5% more likely to become successful than those that only received investment from foreign VC (Dai et al., 2012).
In conclusion, foreign firms are subject to LOF (Dunning, 1977; Zaheer, 1995), stemming from both informal (e.g. Guanxi) and formal (e.g. strong government interference and weak commercial regulations) institutional factors (Williamson, 2000). At the same time,
5
Dai et al.’s (2012) research incorporated cross-border VC investments in Asia over the period of 1996-2002. As such they included India and China in their sample, but the other countries that were included (Taiwan, Singapore, South Korea and Hong Kong) are usually referred to as Newly Industrialized Countries (Worldbank, 2016) rather than EMs.
6
Nahata et al.’s (2014) research incorporated cross-border VC investments from both DMs and EMs, covering the same period as Dai et al’s (2012) research (1996-2002). However, the countries used as frame for the EM did also include Argentina, Brazil, South Africa, Mexico, Malaysia and the Philippines while excluding China.
7
foreign CVCs may be at an advantage in terms of international experience and network, more access to equity and a stronger brand image (e.g. Gu and Lu, 2014; Sethi and Judge, 2009). As a result, previously published literature showed mixed findings in terms of the impact of LOF on VC performance and the likelihood of PC success (Dai et al., 2012; Hu and Hwang, 2010; Nahata et al., 2014). In response, the key considerations that should be made when doing business in China and India is that of the construction of legitimacy and reputation (Gu and Lu, 2014), the maintenance of harmony with the environment, the securement of (political) connections and the inclusion into business networks (Alhstrom and Bruton, 2001, 2006; Chen, 2001; Khan et al., 2016; Wright et al., 2002; Yiu et al., 2005).
2.2 Research Gap
A lot of research has been conducted on VC in general (Gompers and Lerner, 2001; Kortum and Lerner, 2000; Sahlman, 1990). Most of this earlier research took the perspective of VC originating from DMs. And while it has initially been argued that VCs would follow the same worldwide model of investing (Jeng and Wells, 2000), literature on the Indian and Chinese markets (Bruton et al., 2004; Chen, 2001; Khan et al., 2016; Yiu et al., 2005) suggest otherwise. In addition, as most attention is paid to (I)VC, there is room for further academic attention for CVC (Maula et al., 2005). This is justified by taking into consideration the rise of CVC spending in both India and China by foreign and domestic firms alike (CBInsights, 2016; Ernst & Young, 2011). Moreover, as both domestic and foreign CVC are active in these markets, such research would provide an interesting lens typical IB concepts such as LOF and AOF. Earlier studies did investigate the effect of cultural distance on VC but did so taking on a qualitative approach (Bruton et al., 2004; Ahlstrom and Bruton, 2006). Those studies that researched cross-border VC investments (Lu and Hwang, 2010; Dai et al., 2012; Nahata et al., 2014) showed mixed results and did not distinguish between IVC and CVC, while this distinction in an important one (Dushnitsky and Lenox, 2006; Maula et al. 2005). In regards
to syndication, others only investigated the effect of VC syndication on PC Success (Tian, 2011; Gu and Lu, 2014 ), but neglected the potential effect of syndicate compositions, that include GVCs. Finally, despite the presence of recent studies that looked at the interplay between syndication and foreignness (Nahata et al., 2014; Wang, 2016), to my knowledge, there is no existent study that did so in the context of CVC in India and China. In order to fill this gap, I formulated the following research question:
Should Emerging Market entrepreneurs prefer foreign or domestic CVC funding and how does the occurrence and composition of syndication effect this consideration?
2.3 Hypotheses Development
Here, I discuss the hypotheses that follow from the Literature Review and form the basis of the remainder of this study. I present a set of hypotheses that relate to how foreign CVCs and CVC syndication impact PC success. I consider a set of factors. First, I test the effect of foreign CVC investment on PC success. Next, I assess how syndication effects PC success. Finally, I analyse how a differing syndicate composition may effect PC success. Figure 1 shows the conceptualization of the concepts incorporated in this study.
2.3.1 The inter-related effect of LOF and syndication on EM CVC
Firms may face more difficulties investing abroad than in their home markets due to LOF (Sethi and Judge, 2009; Zaheer, 1995). For one thing, foreign VCs are less acquainted with the local institutional context, and often lack knowledge on local culture, regulations and practices (Lu and Hwang, 2010). Foreign firms will have to deal with a dramatically different institutional context than their own as China and India are so distinct from previously entered markets (Ahlstrom et al., 2007; Bruton and Ahlstrom, 2003; Peng, 2003). In an environment where ‘’being connected’’ (Pruthi et al., 2003; Gu and Lu, 2014), and the understanding of behavioral patterns is so crucial (Eden and Miller, 2004), the foreign VC is at serious risk due to its lack of understanding of such an environment. In turn, such an unfamiliar environment
and lack of cultural awareness amplifies the already severe agency problems that VCs experience because of large information asymmetries between VCs and PCs managers (Nahata et al., 2014). Second, Foreign VCs may be at a disadvantage due to a lack of legitimacy, reputation and trust as they are not yet able to put forward long enough successful performance records (Gu and Lu, 2014) or possess the necessary contacts to enhance the local status (Bruton, et al., 2009).
At the same time, Sethi and Judge (2009) recognize that, operating in EMS, foreign firms’ may be able to deploy AOF and AOMs that provide them with potential advantages over domestic firms. As a matter of fact, DM firms are even thought to be more capable than firms from China and India (Peng, 2003; Gu and Lu, 2014). Domestic VCs often operate on a smaller (global) scale and are expected to be less able to offer value-added advice to PCs than their DM counterparts (Bruton and Ahlstrom, 2003). Moreover, international VC firms usually experience advantages originating from a stronger brand name, better fund raising potential and international investment experience (Dai et al., 2012; Lu and Hwang, 2010). Nahata et al. (2014) even found that foreign VCs actually performed better when the cultural distance increased as firms anticipate the ambiguity and therefore perform a much more extensive screening of the PC before actually making the investment.
However, it is important to consider that the above presented reasoning, though relevant, revolves around VC instead of CVC in particular. This distinction is an important one (Maula et al., 2005) and, as I expect, is likely to have crucial implications for the relative success of foreign- versus domestic CVC. First, as CVCs are usually subsidiaries of large MNEs (Chesbrough, 2002), they are likely to indeed benefit from a large international network and a strong brand name. Nonetheless, as CVC subsidiaries are thus initiated by large firms only, I expect domestic CVCs to experience similar benefits from the reputation and business network that its’ mother firm has already established. If anything, the domestic
mother corporation may probably even have a more valuable local network. Second, CVCs differ from traditional VC in their nature and objectives (Chesbrough, 2000; Maula et al., 2005). CVCs are sensitive to changes in the mother-firm’s top management teams. This may cause the firm’s priorities to shift which in the worst case, may mean that the new firm’s management chooses to disrupt or abort the support towards the CVC. In turn, this causes havoc for the PC in which the CVC had committed itself (Block and MacMillan, 1993; Dushnitsky and Lenox, 2009). Indeed, CVC programs are usually more volatile and shorter than traditional VC (Block and MacMillan, 1993; Chesbrough, 2000). Dushnitsky and Lenox (2006) found that only when the investment in the PC delivers substantial strategic returns for the corporation, the support from top management is enduring. In turn, I expect the substantial cultural differences and the geographic distance to aggravate the risk of ceasing management support for two main reasons. One, subsequent CEOs may easily find support to abort distant and risky adventures initiated by their predecessors. Two, both geographical and cultural distance may complicate the successful transfer of strategic assets and therefore result in the abortion of CVC support for the PC, ultimately reducing the PC’s chances of successful exit.
All in all, I expect that the effects of LOF are worsened by the structural deficiencies of CVC. In turn, I expect this to result in lower likelihoods of PC success for foreign-CVC-backed PCs than for domestic-CVC-foreign-CVC-backed PCs. Based on this reasoning, I expect that:
H1a: EM PCs that receive funding from a Foreign CVC are less likely to successfully exit than those that received investment from a Domestic CVC.
In response to the extra investment uncertainty that foreign VCs face, they have a higher propensity towards syndication (Liu and Maula, 2016; Wang, 2016). Multiple syndicate members provide heterogeneous skills, different information, varying industry expertise and networks, ultimately reducing the uncertainty to investors (Sahlman, 1990; Hochberg et al., 2007; Tian, 2011). Maula et al. (2005) found that IVCs assist most with
financial arrangements, recruitment of key staff-members and advice on how to deal with competition. Complementary to such IVC practices, CVCs tend to be more effective in advice on technologies, but also provide more knowledge-based learning benefits and are better able to assist in attracting foreign customers (Maula et. al, 2005). Consequently, syndication-backed PCs face higher likelihoods of exit (Tian, 2011).
I hypothesize that , apart from the above-mentioned traditional arguments that support syndication, the phenomenon may be of even more particular value for CVCs in EMs. First, investment experience helps mitigate the risks that such volatile and highly uncertain markets bring (Dai et al., 2012; Liu and Maula, 2016). Although previous authors (Liu and Maula, 2016; Wang, 2016) looked at how a single VCs’ experience alleviate such risks, I expect the accumulated experience of multiple investors to have a similar impact. Second, previous authors have emphasized the importance of reputation in both the VC industry (Gu and Lu, 2014; Nahata, 2008) as well as in the EMs in general (e.g. Chen, 2001; Peng et al. 2008). As foreign firms often lack reputation (Gu and Lu, 2014; Liu and Maula, 2016), they should look for ways that help build it. Considering the importance that is assigned to collectivism (Hofstede et al., 2010) and the legitimacy that may result from acting in business groups in EMs (Ahlstrom and Bruton, 2006; Khanna and Yafeh, 2007; Sanyal and Guvenly, 2000), I expect syndication by the CVC to positively affect PC success. Thus, I predict:
H1b: The positive effect of syndication on PC success moderates the negative relation described in H1a.
2.3.2 Syndication in India and China: Valuing Domestic and Foreign partners
IB literature predicts that high country-level uncertainty increases the need for partnering (Hennart, 1988) as foreign CVCs themselves lack the knowledge, experience and local connections that are so important in such environments (Eden and Miller, 2004). Subsequently, while foreign CVCs may benefit from syndication with IVCs due to
complementarities in any case (Maula et al., 2005), I expect CVCs that co-invested with a domestic IVC to benefit even more. Indeed, in researching global VC, Dai et al. (2012) found that local partnering alleviates information asymmetries and monitoring problems. Simultaneously, the connections and reputation of the local VC may further mitigate market uncertainty (Eden and Miller, 2004; Wang, 2016). Moreover, domestic VCs may aid the foreign CVC in becoming part of a local business network (Wang, 2016), therewith substantially enhancing the outlook for success (Guillen, 2000; Gu and Lu, 2014; Khanna and Yafeh, 2007). The results of Dai et al. (2012) and Nahata et al. (2014) are based on different sample timeframes than this study and focus most on IVC. I nonetheless expect their findings , showing the beneficial effect of local partnering, to be true for foreign CVCs operating in India and China as well. I have contemplated on the extent to which these CVCs undergo LOF and therefore expect that:
H2a: Co-investment of Foreign CVCs with local VCs increases the likelihood PC success. Whilst foreign CVCs may benefit from the assets provided by a domestic VC, I also believe that domestic CVCs may in turn benefit from co-investment with foreign VCs. Indeed, Nahata et al. (2014) found that increasing cultural distance between the VC and the PC enhances the PC likelihood of success, because of the more rigorous screening that it involves. In other words, local VCs may expect PCs that are funded by foreign firms to have gone through extensive investigation, consequently being more prepared to co-fund the company, increasing the odds of PC success. At the same time, local VCs and PC managers may appreciate the foreign VCs’ home-grown strengths (Dai et al., 2012). Foreign firms benefit from AOF (Sethi and Judge, 2009) such as a strong brand image, the VC’s ability to leverage its international network and its relative advantage in terms of size and experience (Dai et al., 2012; Gu and Lu, 2014). In sum, I expect PCs with both local CVC and foreign VC on board, to benefit from the experience and skills offered by the foreign VC and the
shared knowledge of both the international capital market and the local business environment. Thus, I expect that:
H2b: Co-investment of Domestic CVCs with a Foreign partner increases the likelihood of successful EM PC exits.
2.3.3 Co-investment with Government, overcoming institutional weaknesses.
China, despite its recent adoption of more liberal economic policies, remains a socialist state with one (Communist) Party that still controls vast areas of doing business (Sanyal and Guvenly, 2000). India, though a democratic nation with an Anglo-colonial past, still lacks in many areas of institutional development (Worldbank, 2016). According to the Worldbank’s (2016) Worldwide Governance Indicators (WGI) index, both countries, are underdeveloped in terms of control of corruption, rule of law, regulatory quality, government effectiveness and absence of violence (Kaufman, Kraay and Mastruzzi, 2010).
VC, by default, is a challenging type of business (Christensen, 2000). In DMs, VCs usually reduce risk via thorough due diligence and careful monitoring of the investment (Lerner, 1994; Sahlman, 1990). However, VCs should realize that ,in DMs, the rule of law is well established. In regions where this is not the case these strategies may not always work effectively (Bruton et al., 2004). CVCs operating in India and China should thus look for other ways to further reduce systematic risk in order to become successful. Sanyal and Guvenli (2000) found that foreign MNE’ subsidiaries operating in China become more successful when they maintain good relations with government officials. The main rationale behind the findings of Sanyal and Guvenli (2000) is simple. First, as foreign firms compete with domestic firms, governments may expose pressure on to the foreign firm, putting constraints on the firm’s business. Second, local partners are embedded into the institutional context and have a better understanding of how deeply rooted concepts such as Jugaad (Khanna and Palepu, 2000) and Guanxi (Fan, 2007) work. As such, they are more likely to
know how to develop connections with government officials, consequently benefitting from them. Logically, when foreign firms are able to set up similar connections with host-governments in these countries, they may also benefit from such a highly valuable partner.
In the VC industry, one very salient indication that a particular VC has initiated good relations with the government is when the VC co-invests with a GVC. In VC literature however, there is considerable skepticism surrounding the practice of GVCs (Brander et al., 2015; Lerner, 2009). In the U.S. setting for instance, sole investment by a GVC shows worse performance than that of IVCs (Brander et al., 2010). Nonetheless, Brander et al. (2015) did show that when IVCs co-invested with GVCs, the likelihood of PC success increased. Although these studies did not specifically incorporate China and India, I expect the positive effect of GVC interference to actually be much more significant in these regions due weak institutions and the dominant role of government. Finally, considering that domestic CVCs are locally embedded and have more experience in dealing with the ambiguous laws and regulations, I expect the effect of co-investment with GVCs to be larger for foreign CVCs.
H3a: Foreign CVC Co-investment with a GVC increases the likelihood of PC success. H3b: Domestic CVC Co-investment with a GVC increases the likelihood of PC success. H3c: The beneficial effect of co-investment with a GVC is expected to be larger for foreign
2.4 Conceptual Model
Emerging Market PC successH1a
Emerging Market PC success Total Sample: N= 578 Emerging Market PC successH2a
Foreign CVC VS. Domestic CVC Foreign Sub-Sample: N= 302H2b
Inclusion of GVC in syndicate Foreign CVC co-investment with domestic VCH3a
Domestic CVC co-investment with foreign VCH3b
H1b
Domestic Sub-Sample: N= 276Figure 1: Conceptual Model
Syndication
H3c
Inclusion of GVC in syndicate
31
3. METHODOLOGY
This study aims to explain how the concepts of LOF and syndication (inter-)relate to PC success. Such a study is best defined as an explanatory study with a deductive approach as my hypotheses build on existing literature (Saunders, Lewis and Thornhill, 2012). This chapter elaborates on how the research question is answered, and which variables I used to test the proposed hypotheses. Furthermore, I discuss the database, the sample, the data collection procedure and the method of analysis.
3.1 Sample
I believe it is suitable to research CVC investment in India and China while referring to CVC in EMs. China is the second-largest VC market in the world (Gu and Lu, 2014) and its VC industry has exponentially expanded along with its growing economy (Ahlstrom et al., 2007). India perfectly suits as the second country to draw the sample from for similar reasons. India’s economy has been booming, and its growth rates are expected to outnumber those of China in the near future. Moreover, India was the fifth largest VC market between 2006-2013, while it is projected to surpass Israel and become the fourth largest soon (Ernst and Young, 2015). In response to all this economic activity, both countries have attracted a tremendous amount of foreign investment (Worldbank, 2016). At the same time, despite the economic development that both nations have gone through, institutional development still clearly lags behind that of DMs or Newly Industrialized Economies such as Singapore and South-Korea (IPRI, 2016; Worldbank, 2016). This interesting combination of economic growth and challenging institutions has recently inspired other authors to use the two countries for their VC studies (e.g. Bruton & Ahlstrom, 2003; Dai et al., 2012; Nahata et al., 2014).
I tested the hypotheses with a sample of VC investments from India and China, between 2002-2011. Although the focus of this study is on CVC, other VC investments are also included. As I test for syndication and syndicate composition I obviously needed to include the data of all co-investors. Then, as I distinguish between foreign and domestic
32 CVCs, those PCs that received funding from both were excluded from the dataset8. As a result, the total dataset included 2100 investments made by a total of 551 different firms over a sum of 578 PCs. Subsequently, for this research N = 578. Finally, for hypothesis 2 and 3 I needed to distinguish between those PCs that were endorsed by domestic CVCs (hereafter: domestic subsample) and those that were endorsed by foreign CVCs (hereafter: foreign subsample). Both samples roughly made up half of the total sample; at the descriptive statistics part I provide further insights into the sample characteristics.
I considered VC firms to be a co-investor when they invested in the same PC as the CVC, regardless of the financing round. I assume that relationships between investors are constructed through interaction in board meetings and other value-adding activities that not necessarily come to existence only during the actual investment rounds but throughout the maturation of the PC (following Dai et al., 2012; Hochberg et al., 2007)9. Furthermore, I described the CVC characteristics based on firm level rather than fund level. Following Hochberg et al. (2007) and Gu and Lu (2014), I find this measurement to be most appropriate as I assume that as firms operate subsequent funds, the experience and established networks carry over from the fund to the firm.
3.2 Database
All the investment details are collected from Thomson One, a VC database which was, until recently, known as Platinum Venture Xpert. This database combines various databases provided by national VC associations and is supported by the PWC MoneyTree Survey (Thomson Financial, 2016). Thomson One is considered to be the most comprehensive database on VC, containing investment information for almost every country since 1960
8
Due to the removal of 7 PCs that received funding from both Domestic and Foreign CVCs, the sample size was reduced from 585 to 578 in the last step.
9
Other researchers (for instance, Tian, 2011) have used the more strict definition, defining PC only as syndicate backed when VCs invested in the same rounds. Hochberg et al. (2007) used both approaches and showed that their findings were robust to either definition of syndication.
33 (Gompers and Lerner, 2004). Amongst else, Anokhin et al. (2016), Dai and Nahata (2016) Dushnitsky and Shaver (2009) and Gompers and Lerner (2000) have used Thomson One for their renowned studies.
Although Thomson One is widely used in a range of relevant studies, a potential limitation in respect to the current study may be that the coverage on China’s and India’s market may not be as complete as the coverage of western VC Markets (Dai et al., 2012; Wang, 2016). Still, Thomson One is the most recognized database in the field and has been collecting data on Asian VC markets already since 1962 (Gompers and Lerner, 2004) and has been used by other studies on Chinese and Indian VC markets (Dai et al., 2012; Gu and Lu, 2014; Nahata et al., 2014; Wang, 2016). From Thomson One, I gathered information on PC name, investment date, PC location, PC exit type, firm type, (C)VC location and fund program, the amount of firms that invested in the PC, last investment date details of PC, Size of CVC, experience of CVC and the year the CVC was founded. Appendix 1 provides a further elaboration on all the key variables that Thomson One provides.
3.3 Data collection procedure
Initially, all worldwide private equity investments for the period between January 2002 – December 2015 were extracted. This resulted in a dataset of over 350.000 private equity investments. First, I narrowed this dataset down to only Indian and Chinese PCs. Second, Thomson One provides extensive information on the exit type of each PC, classifying them as either IPO, trade sale or write off. As most PCs on average go through an investment cycle of 3 to 5 years (Sahlman, 1990; Tian, 2011), a substantial part of the PCs that received their very first investment in 2012 or later have not been able to mature10. Consequently, I only included those PCs that received their first investment between 2002 and 2011 and at
10 Although I thus excluded PCs that received their first investment after 2011, I did not exclude all data between
2012–2015 as during these years the PCs that received their first investment before 2011 may still have received investments between 2012-2015.
34 least received CVC investment once. Finally, as I explicitly compare foreign- and domestic CVC backed PCs, I excluded a total of 7 PCs that received funding from both.
Then, in order to determine the exit type I extracted an additional ‘’Exit-type’’ dataset that did cover all known exit data between 2002 and 2016. However, as going into defunct is typically not as widely published as PC success, many of the actual write offs are not recorded as such (Tian, 2011). Therefore, in a substantial amount of the cases, the database did not classify many of the write offs as an actual write off. Following Cumming et al. (2016) and Tian (2011), I classified any PC that not successfully exited within 5 years after its last investment as a write off. Ultimately, all the above mentioned steps resulted in a drastic reduction of the total amount of 355.000 PE investments to total dataset that included 2100 investments made by a total of 551 different firms over a sum of 578 PCs and two subsamples including respectively 276 PCs and 302 PCs.
3.4 Description of Variables
3.4.1 Dependent variable
The Dependent Variable (DV) for this study is PC success. Similar to the approach taken by previous authors (amongst else; Cumming et al., 2016, Dai et al., 2012; Gu and Lu, 2014), I consider a PC to be successful when they either go public via IPO or when they are acquired. Thomson One provides the exit type of the PC as the database indicates whether a PC has successfully been turned into an IPO or Trade Sale (M&A) or unsuccessfully has been liquidated (Write Off). Although this definition of success is measured at the level of the PC, it still tells us something about the CVC as the amount of successful PC exits is as a proxy of the CVC’s own capabilities (Tian, 2011; Yang et al., 2009).
3.4.2 Independent and moderating variables
For Hypothesis 1a the Independent Variable (IV) is Foreign CVC. This IV is a dummy variable that defines whether a PC was funded by a Foreign CVC (1) or by a Domestic CVC (0). The second IV, Syndication, is also a dummy variable. Syndication indicates whether the
35 PC received investment from two or more investors (1) or only received funds from one investor (0). I expect Syndication to function as a Moderating Variable on the relation between Foreign CVC and PC success. Consequently, I computed a third IV which is simply the interaction effect between Foreign CVC and Syndication.
For Hypothesis 2, the analysis took place within the two sub-groups (domestic and foreign subsample) rather than between the two. Within the foreign subsample, the intention was to find out whether co-investment by foreign CVCs with local VCs helps overcome LOF. Within the domestic subsample, I tested whether co-investment of domestic CVCs with foreign VCs increases PC Success due to AOF. To label the PCs accordingly, I created a new variable, which is called DF_syndicate. In the foreign subsample, DF_syndicate thus takes the value (1) when a foreign CVC co-invested in the PC with a domestic VC. Similarly, in the domestic subsample, DF_syndicate takes the value (1) when a domestic CVC co-invested in the PC with a foreign VC.
For hypothesis 3, I introduce the final IV, which I called GVC_syndicate. This IV is a dummy variable that indicates whether GVCs have invested in the PC. Thomson One labels every investor by type, thus also describing which investors are known to be ‘’Government affiliated11’’. As the goal here was to find out how much PC success increases when the CVC affiliates itself with the host government, GVC_syndicate only took the score (1) when the GVC and the PC originated from the same nation.
3.4.3 Control Variables
Apart from the IVs from which I expect that they indeed impact PC success, any given research must consider that there is an almost infinite number of extraneous variables (Blumberg, Cooper and Schlinder, 2008). Although I need not to worry about most of these
11
Thomson One Venture Xpert describes a government affiliated program (at firm level analysis), as either ‘’a program funded by a government agency used to make private equity investments’’, or ‘’a private equity fund formed by a government agency which raises money from outside investors.’’
36 variables, Blumberg et al. (2008) and Saunders et. al. (2012) recommend to include some of them as control variables in an effort to make sure that results are not biased by excluding important aspects from the research. Subsequently, I controlled for several variables.
First, similar to previous authors (Tian, 2011; Yang et al., 2009) I controlled for CVC size, considering that a firm’s size ‘’may approximate resource endowments of corporate investors and therefore influence their CVC activities.’’ (Yang et al., 2009, p.268). CVC size is measured by the total equity ever invested by a firm, as this is a good indicator of the resources that are available to the firm. Initially, I also controlled for CVC experience12 as firms that have invested in a larger number of PCs may have learned from such experience and benefit in subsequent investments (Yang et al., 2009). However, CVC experience and CVC size were extremely correlated, indicating that the two variables were measuring the same construct13. Second, CVC age was included as a control variable as previous VC studies found that the age of a firm is related to PC success (e.g. Barry et al., 1990; Gompers, 1996). Initially I set out to calculate CVC age by deducting the ‘’PC Founded Year’’ from ‘’PC Exit Year’’. However, contrary to all IPO and trade sale exits, Thompson One does not assign an ‘’Exit Year’’ to all write offs. In an effort to ensure an ‘’honest’’ score for CVC age, I decided to use the date at which the PC received its last investment as a proxy, thus taking the difference in years between ‘’PC Founded Year’’ and the date of ‘’Last Investment Received’’ as a measurement.
Apart from CVC size and age, I also included Industry dummies to control for variety in terms of industry rivalry and industry-differences that may exist in terms of growth outlooks (Gompers, 1996; Gu and Lu, 2014). Using the first number of the Standard Industrial Classification (SIC) code that is assigned to each and every PC, I compressed the total
12
I measured CVC experience, using the total amount of PCs that the CVC’s mother firm ever invested in. 13
CVC Experience and CVC Size showed a .994, .980 and .995 correlation in respectively the total sample, domestic subsample and foreign subsample.
37 number of codes into seven different industries14. Appendix 2 shows the U.S. securities and exchange commission’s (2016) SIC-summary and how I further compressed that industry-division. The fourth control variable is that of Exit time which, as the name already implies, controls for the effect of time on PC success. More specifically, considering that the global financial crisis took place during the timeframe of the sample, Exit time may take two values; (1) when it took place in the midst of the financial Crisis (2008-2009) and (0) when the PC exited before or after the crisis. As the date of a write off is often not as clearly defined as that of a successful exit, it was best to use the ‘’last received investment date’’ as proxy for Exit time. The fifth and final control variable is Location. Although China and India are both countries with high economic growth rates and both member states of the BRIC group of countries, their markets may off course differ in terms of IPO climate and M&A activity. As 75.3% of the PCs originate from China, that country is used as a reference. As a result, Location is a dummy variable that takes the value of (1) when the PC originates from India and (0) when the PC is located in China. Table1 presents an overview of all variables used, while appendix 1 provides further clarification on the items that are available in the Venture Xpert database.
14
Initially, I had chosen to distinguish between eight different industries, as this made most sense based on the SIC classification. However, only one PC was classified in ‘’Public Administration’’, after which I classified it in ‘’Utilities’’.
