Skip to main content
Log in

Disclosure, venture capital and entrepreneurial spawning

  • Article
  • Published:
Journal of International Business Studies Aims and scope Submit manuscript

Abstract

Venture capital (VC) funds have been facing increasing regulatory scrutiny since the 2007 financial crisis, particularly with respect to calls for increased disclosure requirements. In this paper, we examine the effect of more stringent securities regulation on the supply and performance of VC, as well as on new business creation (i.e., entrepreneurial spawning). Using country-level and investment-level data from 34 countries over the years 2000–2008, we find that more stringent securities regulation is positively associated with the supply and performance of VC around the world. More stringent securities regulation is also positively associated with entrepreneurial spawning induced by VC. Among different forms of securities regulation, disclosure stands out as having the most economically meaningful impact, which casts doubt on the oft-repeated objections to disclosure in VC – that it would stifle the VC industry, because secrets would have to be revealed to competitors and the public. These findings are robust to numerous robustness checks for endogeneity. The policy implications are clear, however, regardless of endogeneity concerns: VC and entrepreneurship markets are enabled, not curtailed, in countries with better disclosure standards, when one compares the existing differences in disclosure around the world and changes thereto over the 2000–2008 period.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Figure 1

Similar content being viewed by others

Notes

  1. http://www.firstamendmentcoalition.org/index-of-fac-cases/schwarzeneggers-calendars/calpers-settlement-release/.

  2. Although we can collect Thomson Financial VentureXpert data beyond 2008, the data from GEM are not available past 2008. We chose to keep all our data within the more limited range.

  3. We acknowledge that reverse causality is not the only potential problem that results from endogeneity stemming from the non-random nature of corporate finance studies. See Reeb, Sakakibara, and Mahmood (2012) for a list of problems and solutions for endogeneity.

  4. http://www.sba.gov/advo/stats/sbfaq.pdf.

  5. Not all of these companies are backed by VCs.

  6. Rich (2009); similar calls for greater regulation of disclosure in VC markets around the world were made by the Financial Service Authority (FSA, 2006) and the Financial Accounting Standards Board (FASB, 2008).

  7. http://techstartups.blogspot.com/2007/09/venture-capital-consolidation-reflects.html.

  8. La Porta et al. (2006) explain that securities laws do not change frequently over time. For example, much of the securities legislation relevant today in the United States was set forth in the Securities Act of 1933, with the exception of relevant changes introduced by the SOX in 2002 (which we consider in our empirical tests below). There is, however, little or no evidence in the legislative record that SOX was introduced because of the actions of VCs or VC-induced entrepreneurial spawning. Rather, Senator Sarbanes himself stated that the introduction of SOX was to address the “inadequate oversight of accountants, lack of auditor independence, weak corporate governance procedures, stock analysts’ conflict of interests, inadequate disclosure provisions, and grossly inadequate funding of the Securities and Exchange Commission” (Lucas, 2004: 5).

  9. http://www.gemconsortium.org. Results remain and are available upon request.

  10. This figure is aggregated to the country-year level for the country-level analyses.

  11. Because the securities laws indices that we use are specific to one country, we do not attempt to address cross-border VC deals. See Madhavan and Iriyama (2009), Stephan and Uhlaner (2010), Guler and Guillén (2010) and Bruton, Ahlstrom, and Puky (2009) for discussions of this investment scope.

  12. Given the acknowledged potential endogeneity between VC supply and entrepreneurial spawning with securities regulation, as well as the results of a Durbin–Wu–Hausman test (in a former version of the paper, and available upon request), we do not include OLS specifications in the paper. For thoroughness, we have, however, performed this analysis, and results are consistent with those shown in the paper. These OLS specifications are available upon request.

  13. Spawning may likewise be induced by successful VC exits, and our findings are robust to considering exit as the mechanism to induce spawning. These details are not reported below, but are available on request.

  14. We have also performed the analysis using a contemporaneous vector Y. Results are qualitatively identical, and since this specification may suffer from endogeneity issues, we leave it out. Results are available upon request.

  15. We have considered other instruments and other types of regressions, but fail to find evidence that is different from what is reported in the tables presented herein. In addition, we considered a Heckman analysis where we treat the VC supply variable as a first-step regression and spawning as a subsequent outcome variable. (Similar endogeneity checks are provided in, for example, Hoechle, Schmid, Walter, & Yermack 2010.) In order to use a Heckman analysis, we re-created VC supply (activity) by defining it as equal to 1 where supply is above the median, and 0 if it is below the median. The results (available on request) are similar to the IV and simultaneous-equation estimates in Tables 4, 5 and 6 (and to the OLS results, which are unreported but available on request). We have assessed the robustness of these Heckman regressions to different definitions of “VC activity” including, for example, different quartiles and terciles. A binary definition of “VC activity” is admittedly somewhat arbitrary: thus these results are not presented but are available upon request. We thank an anonymous referee for this suggestion.

  16. This refers to the number of VC deals. Legal origin is significantly correlated with two of the proxies for VC supply; however, they are used only in Table 4, and the correlation is minor, at 18%.

  17. Owing to the rarity of regulatory change for individual countries in the sample term, a Granger causality analysis is not possible.

  18. Time dummies are not included, since data are time-invariant.

  19. Clustering around PC yields results that are even stronger than those provided in the paper. We cluster at the country level in this analysis for consistency across empirics within the paper as well as conservatism.

  20. These results are robust to the inclusion of an indicator variable for Sarbanes–Oxley. For brevity these results are excluded, but are available upon request.

  21. In results unreported, we extend the analysis in Table 5 in two ways. First, we consider the importance of the interaction of VC supply with securities regulation relative to other factors known to be important to several factors for entrepreneurs, for example, Expertise and Judicial efficiency. In other contexts there is evidence that VC expertise is important, such as VC-backed IPOs (Nahata, 2008) and VC deal terms (Hsu, 2004). Second, we consider the interactive effect of VC supply with securities regulation relative to Judicial efficiency. In other contexts, there is evidence that the efficiency of the court system explains in part international differences in, for example, IPOs (La Porta et al., 2006) and other investment activity (La Porta et al., 1998). The data indicate that the level of VC Supply is much more important than VC expertise, when interacted with securities regulation. In fact, we did not find any specifications for either variable that show statistical significance for this variable. It should be noted that Expertise is aggregated in these specifications, but, given the complete lack of statistical significance in these regressions, it is unlikely that its importance is greater than the level of VC activity. Collectively, these results suggest that the level of VC activity is not only important in the impact of securities laws on entrepreneurial spawning, it is more important than the expertise of VCs and the efficiency of the court system in a nation.

  22. We owe thanks to an anonymous referee for this helpful suggestion.

References

  • Bergman, N. K., & Nicolaievsky, D. 2007. Investor protection and the Coasian view. Journal of Financial Economics, 84 (3): 738–771.

    Article  Google Scholar 

  • Black, B. S., & Gilson, R. J. 1998. Venture capital and the structure of capital markets: Banks versus stock markets. Journal of Financial Economics, 47 (3): 243–277.

    Article  Google Scholar 

  • Bruton, G., Ahlstrom, D., & Puky, T. 2009. Institutional differences and the development of entrepreneurial ventures: A comparison of the venture capital industries in Latin America and Asia. Journal of International Business Studies, 40 (5): 762–778.

    Article  Google Scholar 

  • Cumming, D. J. 2008. Contracts and exits in venture capital finance. Review of Financial Studies, 21 (5): 1947–1982.

    Article  Google Scholar 

  • Cumming, D. J., & Johan, S. A. 2009. Venture capital and private equity contracting: An international perspective. San Diego: Elsevier Science Academic Press.

    Google Scholar 

  • Cumming, D. J., & Walz, U. 2010. Private equity returns and disclosure around the world. Journal of International Business Studies, 41 (4): 727–754.

    Article  Google Scholar 

  • Djankov, S., La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. 2008. The law and economics of self-dealing. Journal of Financial Economics, 88 (3): 430–465.

    Article  Google Scholar 

  • The Economist. 2009. Finance and economics: Payback time; fund management. 21 November: 77–78.

  • Financial Accounting Standards Board (FASB). 2008. Enhancing the financial accounting and reporting standard-setting process for private companies, Doc. No. 1310-100, June. Norwalk, CT: FASB.

  • Financial Services Authority (FSA). 2006. Private equity: A discussion of risk and regulatory engagement, FSA DP Series 06/2006. London: FSA.

  • Gompers, P., & Lerner, J. 1999. The venture capital cycle. Cambridge, MA: MIT Press.

    Google Scholar 

  • Gompers, P., Lerner, J., & Scharfstein, D. 2005. Entrepreneurial spawning: Public corporations and the genesis of new ventures, 1986 to 1999. Journal of Finance, 60 (2): 577–614.

    Article  Google Scholar 

  • Guler, I., & Guillén, M. 2010. Institutions and the internationalization of US venture capital firms. Journal of International Business Studies, 41 (2): 185–205.

    Article  Google Scholar 

  • Hand, J. R. M. 2005. The value relevance of financial statements in the venture capital market. The Accounting Review, 80 (2): 613–648.

    Article  Google Scholar 

  • Hazaruka, S., Nahata, R., & Tandon, K. 2009. Success in global venture capital investing: Do institutional and cultural differences matter? Working Paper, Baruch College, New York.

  • Hoechle, D., Schmid, M., Walter, I., & Yermack, D. 2010. How much of the diversification discount can be explained by poor corporate governance? Journal of Financial Economics, 103 (1): 41–60.

    Article  Google Scholar 

  • Hsu, D. 2004. What do entrepreneurs pay for venture capital affiliation? Journal of Finance, 59 (4): 1805–1844.

    Article  Google Scholar 

  • Kedrosky, P. 2009. Right-sizing the US venture capital industry. Ewing Marion Kauffman Foundation (mimeo).

  • Knill, A. 2009. Should venture capitalists put all their eggs in one basket? Diversification versus pure play strategies in venture capital. Financial Management, 38 (3): 441–486.

    Article  Google Scholar 

  • La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. 1998. Law and finance. Journal of Political Economy, 106 (6): 1113–1155.

    Article  Google Scholar 

  • La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. 2006. What works in securities laws? Journal of Finance, 61 (1): 1–32.

    Article  Google Scholar 

  • Lucas, N. 2004. An interview with United States Senator Paul S. Sarbanes. Journal of Leadership & Organizational Studies, 11 (1): 3–8.

    Article  Google Scholar 

  • Madhavan, R., & Iriyama, A. 2009. Understanding global flows of venture capital: Human networks as the “carrier wave” of globalization. Journal of International Business Studies, 40 (8): 1241–1259.

    Article  Google Scholar 

  • Megginson, W., & Weiss, K. 1991. Venture capitalist certification in initial public offerings. Journal of Finance, 46 (3): 879–903.

    Article  Google Scholar 

  • Nahata, R. 2008. Venture capital reputation and investment performance. Journal of Financial Economics, 90 (2): 127–151.

    Article  Google Scholar 

  • Reeb, D., Sakakibara, M., & Mahmood, I. 2012. Endogeneity in international business research. Journal of International Business Studies, 43 (3): 211–218.

    Article  Google Scholar 

  • Rich, B. 2009. Private equity at risk: Private equity, hedge and venture funds are all going to be regulated. Will it squeeze out the small players? http://www.forbes.com/2009/07/08/private-equity-regulation-intelligent-investing-risk.html.

  • Samila, S., & Sorrensen, O. 2011. Venture capital, entrepreneurship and economic growth. Review of Economics and Statistics, 93 (1): 338–438.

    Article  Google Scholar 

  • Spamann, H. 2010. The “antidirector rights index” revisited. Review of Financial Studies, 23 (2): 467–486.

    Article  Google Scholar 

  • Stephan, U., & Uhlaner, L. 2010. Performance-based vs socially supportive culture: A cross-national study of descriptive norms and entrepreneurship. Journal of International Business Studies, 41 (8): 1347–1364.

    Article  Google Scholar 

  • Stuart, T., & Sorenson, O. 2003. Liquidity events and the geographic distribution of entrepreneurial activity. Administrative Science Quarterly, 48 (2): 175–201.

    Article  Google Scholar 

Download references

Acknowledgements

We would like to thank Sofia Johan, James Ang, Yingmei Cheng, Nathan Mauck, Gordon Smith, Daniel Sokol and the seminar participants at York University, Florida State University, EMLYON and Durham Busines School as well as conference attendees at the Law & Entrepreneurship Conference as well as the meetings for the European Financial Management Association, Northern Finance Association, Financial Management Association, and the French Finance Association (AFFI). Douglas Cumming owes thanks to the Social Sciences and Humanities Research Council of Canada for financial support. We would especially like to thank David Reeb for his outstanding assistance as Editor in the completion of this paper.

Author information

Authors and Affiliations

Authors

Additional information

Accepted by David Reeb, Area Editor, 18 January 2012. This paper has been with the authors for five revisions.

Appendices

APPENDIX A

Table A1

Table A1 Variable definitions and sources

APPENDIX B

Table B1

Table B1 Supporting statistics for IV regressions in Table 4

Rights and permissions

Reprints and permissions

About this article

Cite this article

Cumming, D., Knill, A. Disclosure, venture capital and entrepreneurial spawning. J Int Bus Stud 43, 563–590 (2012). https://doi.org/10.1057/jibs.2012.9

Download citation

  • Received:

  • Revised:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1057/jibs.2012.9

Keywords

Navigation