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Cost of experimentation and the evolution of venture capital

Author

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  • Ewens, Michael
  • Nanda, Ramana
  • Rhodes-Kropf, Matthew
Abstract
We study how technological shocks to the cost of starting new businesses have led the venture capital model to adapt in fundamental ways over the prior decade. We both document and provide a framework to understand the changes in the investment strategy of venture capitalists (VCs) in recent years – an increased prevalence of a “spray and pray” investment approach – where investors provide a little funding and limited governance to an increased number of startups that they are more likely to abandon, but where initial experiments significantly inform beliefs about the future potential of the venture. This adaptation and related entry by new financial intermediaries has led to a disproportionate rise in innovations where information on future prospects is revealed quickly and cheaply, and reduced the relative share of innovation in complex technologies where initial experiments cost more and reveal less.

Suggested Citation

  • Ewens, Michael & Nanda, Ramana & Rhodes-Kropf, Matthew, 2018. "Cost of experimentation and the evolution of venture capital," Journal of Financial Economics, Elsevier, vol. 128(3), pages 422-442.
    • Handle: RePEc:eee:jfinec:v:128:y:2018:i:3:p:422-442
    DOI: 10.1016/j.jfineco.2018.03.001
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    More about this item

    Keywords

    Innovation; Venture capital; Entrepreneurship; Investing; Abandonment options;
    All these keywords.

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • O31 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Innovation and Invention: Processes and Incentives

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