Ebook Production Modes in China’s Venture Capital Finance Sector: An Empirical Study on Stage Financing in China
Entrepreneurial R&D activities are vitally important for innovation, and, consequently for economic development. However, it is very hard to finance young R&D-oriented companies due to the pronounced information asymmetry problems and institutional issues. Venture capital investment has been recognized as one of the most effective ways in dealing with the agency problems associated with R&D financing and promoting innovation. Many nations started to imitate the ‘Silicon Valley Model’ since the mid-1980s with the expectation to stimulate entrepreneurial R&D activities. Nonetheless, the development of the venture capital markets is far from homogeneous around the world, and, even within the United States. This phenomenon raises extensive interests from researchers to find out the factors that affect the outcomes of transplanting venture capital investment to different countries.
The role of institutions played on financial activities has long been debated in the literature. Some researchers suggest that the differences in institutions, especially the divergence in financial and legal systems, are the major factors that impact on corporate performance and business behaviors across countries (La Porta et al., 1997, 1998; Allen & Gale, 1999; Rajan&Zingales; 2003). From cross country studies, it is known that VCs’ investment behaviors depend on the institutions of the countries where they operate. Researchers suggest that stronger institutions lead to more active VCs’ involvements in the management of their portfolio companies and more usage of innovative governance mechanisms, and, consequently lead to more developed venture capital markets (Kaplan et al., 2003; Cummings et al., 2003; Jeng and Wells, 2000).
Since the mid-1980s, China’s venture capital industry has experienced a dramatic transformation together with the institutional and technological changes during China’s transition from a centrally planned economy to a more market-oriented economy. China has become one of the most active nations in initiating venture capital investment programs. Since 2001, China’s venture capital market (including Hong Kong) has been ranked the 2nd in the world in terms of the annual disbursement of investment. Many of the most successful new technological companies in China are backed by venture capital funds. At the same time, China is becoming one of the most favored investment destinations for VCs around the world. In 2004, venture capital investment made by foreign and joint venture capital investment organizations consisted over 75 percentage of the total investment in the country.
However, it is documented that Chinese financial and legal institutions are outrageously weak (Allen et al., 2005). Thus, it is anticipated that VCs’ investment activities in China should be substantially different from those in developed countries. Yet, systematic empirical research on China’s VC and related institutions is desperately lacking. This research therefore contributes to the existing literature by examining the impact of institutions on VCs’ investment activities in China through stage financing.
Stage financing is widely deployed in venture capital investment in the US. Normally, VCs do not invest the capital needed by entrepreneurs in full upfront. Rather, they evaluate the projects periodically and provide the funds by installments according to the performance of the projects. In this way, VCs retain the option to abandon the venture if the pre-set milestones are not achieved or the venture shows negative signals.
Stage financing has been recognized as an effective way in dealing with agency problems in venture financing. Theorists suggest that stage financing may serve as a ‘pay-for-performance’ incentive mechanism to entrepreneurs since the decisions for next financing rounds depend on the performance of previous stages (Cornelli and Yosha, 2004). Furthermore, the growing physical assets over stages may serve as collaterals for further investment that the ‘hold-up’ problems may be controlled (Neher, 1999). At the same time, stage financing may also serve as a signaling mechanism that good entrepreneurs may signal their capability and confidence in the projects by accepting this ‘pay-for-performance’ contract (Lazear, 1986).
Posted in :
