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Article

Venture Capitalists on Boards and Corporate Innovation

by
Li Jing
* and
Huiying Zhang
*
College of Management and Economics, Tianjin University, Tianjin 300072, China
*
Authors to whom correspondence should be addressed.
J. Risk Financial Manag. 2023, 16(3), 143; https://doi.org/10.3390/jrfm16030143
Submission received: 26 December 2022 / Revised: 27 January 2023 / Accepted: 5 February 2023 / Published: 21 February 2023
(This article belongs to the Special Issue Organizational Innovation, Financial Technology and Technology Management)
Versions Notes

Abstract

:
Venture capital has a significant positive impact on corporate innovation. However, innovation has great risks. Investors often lack sufficient confidence in innovation, which often leads to investors stopping their investment or to inadequate support for innovation behavior. Therefore, enhancing investor confidence is crucial. Monitoring is considered to be the most direct and common way to promote investor confidence. This paper mainly focus on the effect of venture capitalist monitoring on corporate innovation. We use companies listed in the Shenzhen and Shanghai stock exchanges from 2009 to 2017 as samples. We performed a metrological test and a series of robustness tests and found that venture capitalists on boards play a significant role in promoting corporate innovation. When dividing the sample according to the experience of venture capital or the governance level of the corporation, we found that venture capitalists on boards with high experience or in corporations with high-quality governance have a greater impact on corporate innovation. Furthermore, we studied the monitoring mechanism of venture capital on boards and found that the monitoring of venture capital can alleviate managers’ anxiety about being dismissed due to innovation failure.
Keywords:
venture capitalists on boards; innovation; career concern
JEL Classification:
G24; G34; O31

1. Introduction

Innovation presents high uncertainty and requires a large amount of capital investment, so it is a high-risk behavior. Demand for capital is the often last straw crushing the camel’s back in most cases. Venture capital can provide capital to corporations starved of capital for innovation and can promote corporate innovation (Bottazzi et al. 2008; Forti et al. 2020; Hsu 2006; Colombo et al. 2016; Galloway et al. 2017; Tian and Wang 2014).
However, the high-risk nature of innovation may lead to insufficient venture capital investment due to information asymmetry or management’s unwillingness to take risks, resulting in a decline in corporate innovation (Cornaggia et al. 2015; Holmstrom 1989). Through monitoring venture capital investment, information asymmetry between the two sides of the investment can be alleviated (Caselli et al. 2013; Chahine and Zhang 2020; Ewens and Marx 2018; Lerner 1995). Many studies have measured this monitoring behavior in a rather vague way, such as relevant rights -through contract terms (Burchardt et al. 2016; Kaplan and Strömberg 2003), direct interactions with corporations or sending someone to portfolio companies (Bengtsson and Hsu 2015; Lerner 1995), enhancing the proportion of independent directors (Baker and Gompers 2003; Suchard 2009), replacing the CEO (Conti and Graham 2020; Ewens and Marx 2018), and executive compensation (Baker and Gompers 2000; Bengtsson and Hand 2013; Kaplan and Strömberg 2004; Sun et al. 2018). However, these measures of monitoring behavior are very imperfect, and it is difficult to control for the influence of other potential factors.
This study use venture capitalists on boards to measure venture capital monitoring. This is a very clear and direct act of monitoring. We found that venture capitalists on boards can promote innovation in portfolio companies. When dividing the sample according to the experience with venture capital or the governance level of the corporation, we found that venture capitalists on boards with high experience or in the corporations with high-quality governance have a greater impact on corporate innovation.
The theories of “career concern” and “quiet life” are considered to be two important explanations in corporate governance and innovation (Aghion et al. 2013; Jiang and Yuan 2018). Both of these can explain the promotional effect of VC monitoring on portfolio company innovation, but which one works best has not been clearly answered thus far. Previous studies on the impact of venture capital monitoring on corporations have not distinguished between these two theories. However, these different theories lead to completely different practical behaviors, and it is therefore important to distinguish between them. We test the career theory and quiet life theory to identify which theory one works best and found that venture capitalists on boards can relieve managers’ worries about their careers. This conclusion is consistent with the career concern theory.
The main contributions of this paper are as follows: first, monitoring is a very important method to reduce information asymmetry. However, previous literature has measured the level of monitoring very imprecisely, such as by using relevant rights through contract terms (Burchardt et al. 2016; Kaplan and Strömberg 2003), directly interacting with corporations, sending someone to portfolio companies (Bengtsson and Hsu 2015; Lerner 1995), increasing the proportion of independent directors (Baker and Gompers 2003; Suchard 2009), executive compensation (Baker and Gompers 2000; Bengtsson and Hand 2013; Kaplan and Strömberg 2004; Sun et al. 2018), or replacing the CEO (Conti and Graham 2020; Ewens and Marx 2018). Although these studies have used various ways to control the influence of other factors, the measurement of monitoring behavior is still inaccurate. We use the venture capitalists on boards to clearly measure the level of monitoring. This study not only re-examines the impact of monitoring on corporate innovation, but also provides more direct evidence of its impact. The remainder of the paper is organized as follows. Section 2 discusses the “career concern” and “quiet life” theories, as well as VC monitoring of innovation portfolio companies. Section 3 develops our hypotheses. Section 4 introduces the sample, data, and research methodology. Section 5 shows empirical results. Section 6 concludes and shares the practical significance of the results.

2. Literature Review

2.1. The Monitoring Mode of VC and Innovation

In order to alleviate the information asymmetry between investors and corporations, VCs usually take on a variety of forms of monitoring to reduce investment risk (Chahine and Zhang 2020; Dessi 2005; Ewens and Marx 2018; Gompers 2012; Kaplan and Strömberg 2003). VCs mainly perform direct monitoring or rely on internal governance mechanisms to achieve indirect monitoring. For direct monitoring, VC often accquire relevant rights through contract terms (Burchardt et al. 2016; Kaplan and Strömberg 2003), directly interact with corporations, or send someone to the portfolio companies (Bengtsson and Hsu 2015; Lerner 1995). For indirect monitoring, VCs can increase the proportion of independent directors (Baker and Gompers 2003; Suchard 2009) and executive compensation (Baker and Gompers 2000; Bengtsson and Hand 2013; Kaplan and Strömberg 2004; Sun et al. 2018) or replace the CEO (Conti and Graham 2020; Ewens and Marx 2018).
A large number of studies have shown that VC monitoring can increase the R&D investment and innovation output of portfolio company (Celikyurt et al. 2014) and improve total factor productivity (Chemmanur et al. 2011) and business performance (Bernstein et al. 2016; Celikyurt et al. 2014). Corporations with venture capital investment can achieve IPO in a shorter time and with lower IPO underpricing (Cho and Lee 2013; Sohn and Hur 2012). In addition, the innovation ability of the corporation becomes stronger (Shin 2020). There are two main reasons for this. First of all, due to the high-risk characteristics of innovation, managers naturally have an aversion to innovation, which leads to insufficient input and low efficiency. VC monitoring can improve the quality of internal governance (Hochberg 2012; Liao et al. 2014) and effectively reduce the opportunistic behavior of managers (Hochberg 2012). Hochberg and Nam found that VCF monitoring can effectively reduce earnings management (Hochberg 2012; Nam et al. 2014). Secondly, VCs can obtain firm operation information through monitoring, formulate a more effective salary contract for managers, effectively reduce managers’ attention to corporate short-term performance (Cao et al. 2014; Engel et al. 2002), realize better “binding” between managers and business performance (Allcock and Filatotchev 2010; Bonini et al. 2012; Sun et al. 2018), and improve a firm’s innovation. Huang found that VCs can promote firm innovation by increasing the level of executive compensation. Finally, VCF monitoring can obtain more business information, improve the tolerance for failure, and promote innovation. Tian found that the failure tolerance of a VC can improve innovation (Huang and Wang 2019). Bernstein conducted quasi-natural experiments using the opening of new routes, and found that the opening of new routes is conducive to communication between VCs and entrepreneurs, promoting innovation (Bernstein et al. 2016). Although the monitoring of venture capital is beneficial to a firm’s innovation, it still has the following imperfections: First of all, studies on the effect of venture capital on the innovation of the portfolio company mainly focus on VCF value-added services and VCF indirect monitoring. Among them, the description of VC monitoring only looks at VCs’ investments, and there is no distinction between different monitoring methods. Studies on VC direct monitoring mainly focus on IPO and short-term business performance. Therefore, the literature on the impact of VC direct monitoring on firm innovation is relatively lacking. Second, in studies on the impact of VC monitoring, the role of venture capital monitoring is to reduce the agency cost of managers. The theories of “career concern” and “quiet lift” are the two most important theories to explain monitoring and corporate performance; however, we do not not know which one works best. We therefore aim to make up for these knowledge gaps.

2.2. “Career Concern” and “Quiet Life”

“Career concern” and “quiet life” are the two most important explanations for the relationship between monitoring and corporate innovation (Aghion et al. 2013; Bernstein 2015; Gormley and Matsa 2016; Jiang and Yuan 2018). According to the “career concern” theory, a manager’s ability is difficult to observe directly and is usually measured by business performance. Once business performance declines, they will face the pressure of salary reduction or dismissal. Therefore, managers may adjust their own behavior to reduce the potential risks; they tend to reduce risk-taking and allocate resources to low-risk projects, which leads to a failure to innovate (Aghion et al. 2013; Jiang and Yuan 2018). Previous studies have shown that the agency cost caused by managers’ worries about their own career can be reduced by adjusting the tolerance of failure and offering longer contracts. Aghion and Jiang found that institutional investors can alleviate managers’ worries about their career and promote corporate innovation (Aghion et al. 2013; Jiang and Yuan 2018). On the other hand, the “quiet life” theory holds that managers are thought to be reluctant to make efforts toward innovation, but want to maintain their current positions (Bertrand and Mullainathan 2003) and have the motivation to pursue a “quiet life”. Such “lazy” managers lead to a decline in company performance, especially due to their lack of investment in high-risk projects (Bertrand and Mullainathan 2003; Shi et al. 2017). Previous studies have shown that improvement in monitoring or increasing the intensity of market competition are helpful to reduce the manager’s pursuit of a quiet life (Aghion et al. 2005).

3. Hypothesis Development

Venture capitalists on boards enhance corporate innovation for several reasons. First, according to the “quiet life” theory, managers are reluctant to put in effort and instead pursue job stability. Such managers reduce investment in high-risk projects and thus affect business performance (Aghion et al. 2013; Bertrand and Mullainathan 2003; Shi et al. 2017). The high risk of innovation may lead to a moral hazard for managers, reduce R&D investment, and damage the long-term interests of portfolio companies (Aghion et al. 2013; Bernstein 2015; Holmstrom 1989). Venture capitalists on boards can easily observe managers’ laziness and punish or fire them. In order to maintain their position, managers will thus actively reduce their pursuit of a “quiet life”. Therefore, venture capitalists on boards can enhance innovation. Second, the failure of innovation may come from managers but also from the technology itself. However, the manager market cannot accurately identify the source of innovation failure. If the innovation fails, managers may be regarded as incompetent, and they will be confronted with lower pay or unemployment. This will lead to managers investing resources in low-risk projects and a decline in innovation (Aghion et al. 2013; Jiang and Yuan 2018). Venture capitalists on boards can obtain more information and better assess the ability of managers, enhancing tolerance for innovation failure (Hochberg 2012; Tian and Wang 2014). Therefore, venture capitalists on boards can alleviate managers’ worries about career and promote corporate innovation. In conclusion, Hypothesis 1 is proposed:
Hypothesis 1. 
Venture capitalists on boards can promote corporate innovation.
Monitoring can effectively reduce the agency costs of managers. However, due to the strong subjective initiative for innovation, excessive monitoring may not fully utilize a manager’s talents, resulting in “rigid” and conservative behavior (Edmans 2014; Dhillon and Rossetto 2015; Ortega-Argiles et al. 2005). Venture capitalists on boards with high levels of experience not only know how to be an active investor but also know what to do to become a “qualified” investor. By setting reasonable terms, constraining and motivating managers, the VC can encourage managers to pursue the corporation’s long-term performance (Gompers et al. 2010; Sørensen 2007; Yang et al. 2009). In addition, compared with low-experience VCs, high-experience VCs tend to replace CEOs and improve board independence and be more active in corporate governance (Krishnan et al. 2011). More active monitoring can reduce managers’ career concerns or their pursuit of a “quiet life”. Therefore, compared with the low-experience venture capitalists, the high-experince VCs on boards can supervise managers more actively and effectively, increase the cost of a manager’s pursuit of a quiet life, and relieve the manager’s worries about their career. In conclusion, Hypothesis 2 is proposed:
Hypothesis 2. 
Compared with low-experience venture capitalists on boards, high-experience venture capitalists have a more significant effect on corporate innovation.
Improving the monitoring of managers can reduce the agency cost of managers (Aghion et al. 2013; Li et al. 2017). In different corporate corporations, due to the different levels of quality of governance, the impact of venture capital investment on a portfolio company is also different. In firms with good-quality governance, the impact of venture capital on its portfolio company’s innovation is relatively small, because the agency cost of managers has been effectively controlled in by the good governance quality. However, when corporate governance is poor, the opportunity cost of managers is relatively larger and managers may pursue a quiet life. This is where venture capitalists on boards can significantly affect managers. Managers are pushed by VCs to invest more in innovation. To sum up, in the case of different levels of quality of corporate governance, there are differences in the impact of VC directors on corporate innovation.
Hypothesis 3. 
Venture capitalists on boards can significantly improve the innovation of a portfolio company with low-quality governance.

4. Sample, Data, and Methodology

4.1. Sample and Data

This paper selects the companies listed in the Shenzhen and Shanghai stock exchanges from 2009 to 2017 as samples. We focus on the impact of venture capital as a director on the innovation of the portfolio company and further select sample corporation for analysis. Due to the relatively high innovation ability of manufacturing firms, we choose firms in this sector for the sample. Secondly, firms whose cumulative patent applications amoun to zero in the three years before IPO are excluded. Finally, we obtained a sample of 868 firms. Judgment of whether firms are supported by venture capital mainly depends on whether the business scope of the top ten shareholders includes “equity investment” or “venture capital” at the time of IPO, and further according to the exit data of venture capital from the Qingke private equity database (Cao et al. 2014; Hochberg 2012). Qingke private equity is an investment database of China’s venture capital. Other data on the sample enterprises are obtained from CSMAR.

4.2. Empirical Models

This paper mainly tests the impact of venture capitalists serving as directors on portfolio company innovation and uses the number of patent applications to measure innovation. Referring to Jiang (Jiang and Yuan 2018), this paper uses the OLS regression model to test the following hypothesis:
lnPat = α_0 + α_1 ∗ MONIT + α_2 ∗ control + α_3 year + α_4 ∗ ind + ε
where lnpat indexes corporate innovation and venture capitalists on boards are represented by MONIT. This paper’s analytical focus is α_1, which indicates the relation between venture capitalists on boards and portfolio company innovation. α_1 is expected to be positive if venture capitalists on boards lead to greater portfolio company innovation. We winsorize all continuous variables at the 1% and 99% levels to mitigate the effects of outliers. Furthermore, following Jiang and Yuan (2018), standard errors are clustered at the firm level to account for any possible correlations between firms.

4.3. Variable Definition

4.3.1. Innovation

In this study, we use the number of patents applied by corporations as a proxy for corporate innovation. In the literature on corporate innovation, scholars mostly use the number of patent applications, the number of patents obtained, R&D expenditures, total factor productivity, and other indicators to measure corporate innovation (Aghion et al. 2013; Bernstein 2015; Jiang and Yuan 2018; Tan et al. 2020; Chemmanur et al. 2011). Despite the use of patents as a proxy for corporate innovation being rough, considering the objectivity of patents, a large number of studies usually use this proxy anyway (Hagedoorn and Cloodt 2003; Tan et al. 2020; Wang and Hagedoorn 2014). Following Tan et al. (Tan et al. 2020),we use the logarithm of the number of patent applications by corporations as a proxy for corporate innovation.

4.3.2. Venture Capitalists on Boards

As a measure of whether the members of the board are appointed by VC or venture capitalists on boards (Cao et al. 2014; Takahashi et al. 2018), 1 represents the presence of venture capitalists on boards and zero respresent their absence. This measurement is recorded as MONIT.

4.3.3. Control Variables

We control a series of variables that may affect the innovation activities: AGE, the number of years a firm has been listed (Cao et al. 2014); SIZE, the natural logarithm of the firm’s book value of assets (Elston et al. 2016; Firth et al. 2006); LEV, the ratio of total assets to liabilities (Cao et al. 2014); ROA, ratio of total profit to total assets (Jiang and Yuan 2018); Cash, logarithm of the total amount of cash (He and Tian 2018); RD, logarithm of total R&D investment (Hussinger et al. 2018); TOP10, total share held by the top ten shareholders; and BDN, total number of directors (Fu 2019); IBD, ratio of total board members to independent directors (Lu and Wang 2018; Sun et al. 2018; Fu 2019). We also include industry and year dummies as controls. All variables are defined in Table 1.

5. Empirical Result and Analysis

5.1. Descriptive Statistics and Correlation Analysis

Table 2 shows the descriptive statistics of variables in the model. It can be seen from panel A that there is a big difference in the number of patent applications by firms in IPO, among which the minimum value is 0 and the maximum value is 6.288. Table 3 shows a summary of variable correlations. It can be seen from Table 3 that the correlation coefficient between MONIT and lnpat is 0.078, and it is significant at the 5% level. This shows that there is a significant positive relationship between venture capitalists on boards and portfolio company innovation.

5.2. Main Regression Results

Using a regression model, we analyze the relationship between venture capitalists serving as directors and enterprise innovation. Column 1 of Table 4 reports the control variables. ROA, CASH, RD, BDN, and IBD are all positive and significant. However, we did not find a significant relationship between the age and size of a firm and its innovation. Column 2 tests the impact of venture capitalists serving as directors on the portfolio company’s innovation. The coefficient of MONIT is 0.145 and is significant at the 5% level. The coefficient of MONIT is 0.191 and significant at the 1% level in Column 3. The results of these columns provide support for our first hypothesis that venture capitalists on boards can significantly enhance the portfolio company’s innovation.
High-experience VCs are more active in corporate governance and have greater impact on corporate innovation. We further discuss the impact of venture capitalists on boards with different levels of experience on a portfolio company’s innovation. The samples were divided into two groups according to the average level of experience: high experience and low experience. Column 1 of Table 5 shows the results with low experience and Column 2 the results with a high level of experience. The coefficient of MONIT is 0.160 in Column 1, but is not significant. The coefficient of MONIT is 0.249 in Column 2 and significant at the 5% level. This is consistent with the previous conclusion. VCs with high levels of experience not only know how to be an active investor but also know what to do to become a “qualified” investor. By setting reasonable terms and monitoring methods, VCs can restrict and motivate managers to pursue the long-term performance of corporations (Gompers et al. 2010; Sørensen 2007; Yang et al. 2009). In addition, compared with low-experience VCs, high-experience VCs are more actively involved in corporate governance (Krishnan et al. 2011). Therefore, Hypothesis 2 is confirmed, and Hypothesis 1 is verified again.
We believe that venture capitalists serving as directors can promote enterprise innovation, mainly because venture capitalists can better achieve monitoring, improve corporate governance, and enhance a portfolio company’s innovation. In firms with good corporate governance, since the agency cost of its managers has been effectively controlled, the impact of VC monitoring on reducing the agency cost of managers may not be obvious. However, in the corporations with poor corporate governance, the agency cost of managers is relatively high, so the monitoring effect of venture capitalists is relatively greater. Therefore, in the case of different levels of quality of corporate governance, there are differences in the impact of venture capitalists serving as directors on corporate innovation. Following Jiang et al. (Jiang and Yuan 2018), this paper uses eight variables of corporate governance (the shareholding ratio of the largest shareholder, the shareholding ratio of the second to the tenth largest shareholders, the proportion of external directors, the audit institution, whether cross listing is present, whether it is a state-owned enterprise, whether a CEO and the chairman are concurrently active, and whether the company has a parent company) to construct the corporate governance quality indicators. The samples were divided into two groups according to the average level of governance quality. Column 3 of Table 5 is shows results of firms with high-quality governance and Column 4 show those of firms with a low quality of governance. The coefficient of MONIT is 0.195 in Column 3 and significant at the 10% level and is 0.141 in Column 4, but not significant. Therefore, Hypothesis 3 is confirmed, and Hypothesis 1 is verified again.

6. Robustness Tests

In order to verify the robustness of our conclusions, using alternative proxies for corporate innovation and VC monitoring, the Heckman two-stage method and PSM were used for verification. First of all, following Tan et al. (2020), the explanatory variable in the model was replaced by the number of patent applications. The results are reported in Column 1 of Table 6. The coefficient of MONIT is 0.283 in Column 1, which is significant at the 1% level. The conclusion is therefore still valid.
Secondly, venture capitalists serving on boards represents direct monitoring. Thus, we use a looser variable to measure the monitoring of venture capital: whether the corporation is invested in by venture capital or not. The coefficient of vcif is 0.176 in Column 2, which is significant at the 5% level. The conclusion is therefore still valid.
Next, the previous sections suggest that VCs screen firms, and thus their investment is not random. Following Otchere and Vong (2016) and Chemmanur et al. (2011), the Heckman stage method is used. In the first stage of the two-stage Heckman method, the corporate characteristics and investment heat in the region where the corporation is located are used to predict whether a VC holds board seats or not. The inverse Miller factor (IMR) is calculated to account for endogenous selection (based on unobservable factors). In the second stage, IMR is introduced into the equation. The results are reported in Columns 3 and 4 of Table 6. The coefficient of MONIT is 0.142 in Column 4, which is significant at the 5% level. The conclusion is therefore verified again.
Finally, we use tendency value matching to test the robustness. We use the one-to-one nearest neighbor matching method to match the samples. The results are reported in Column 5 of Table 6. The coefficient of MONIT is 0.145 in Column 5, which is significant at the 5% level. The conclusion was thus verified again.

7. Career Concerns or the Quiet Life Hypothesis: Which Theory Works?

The abilities of managers are difficult to observe and are usually measured by business performance. Once a manager is dismissed because of poor business performance, he will be confronted with lower pay or unemployment. Managers pay attention to their “career” and usually choose projects with less fluctuation in cash flow to reduce the risk of damage to their wealth or unemployment (Aghion et al. 2013; Bernstein 2015; Gormley and Matsa 2016; Holmström 1999). The reason for the failure of innovation may come from the technology or from the effort of the managers (Holmstrom 1989; Manso 2011). Once the manager is dismissed because of the failure to innovate, they may be recognized as incompetent by the market and will face the risk of employment and future salary declines. Managers usually avoid innovation out of self-interest (Aghion et al. 2013; Bernstein 2015; Gormley and Matsa 2016). Venture capitalists on boards can obtain more portfolio company information and improve the tolerance for innovation failures. In addition, through the information obtained, venture capitalists can formulate a better and more reasonable salary system and relieve managers’ worries caused by “career concern”. Therefore, according to the career concern theory, venture capitalists on boards can reduce managers’ worries about “career concern” and promote the portfolio company’s innovation.
Managers are considered to be “lazy”, unwilling to work hard, and as pursuing a quiet life (Aghion et al. 2005; Bertrand and Mullainathan 2003). The manager’s pursuit of a quiet life will lead to reduced investment efficiency and affect business performance (Aghion et al. 2013; Bertrand and Mullainathan 2003; Shi et al. 2017). Because innovation requires great effort, managers naturally have an aversion to innovation (Holmstrom 1989). Venture capitalists on boards can better supervise these managers, identify their “quiet” behavior, and increase the personal cost of pursuing “quiet life”. In order to obtain the private benefits brought by “retention”, managers will be pushed to increase investment and promote corporate innovation (Aghion et al. 2013; Bertrand and Mullainathan 2003). Based on the quiet life theory, venture capitalists on boards can increase the opportunity cost of managers pursuing a “quiet life” and promote portfolio company innovation.
Career concerns or the quiet life hypothesis: which one works best? Following Jiang, Bernstein, and Aghion, we use the number of CEOs concurrently serving as the chairman of the board to measure managerial entrenchment. We divided the study sample into two groups according to whether the CEO is also the chairman of the board of directors. The results are reported in Table 6. Column 1 of Table 7 shows the results when the CEO is also the chairman of the board of directors, and Columns 2 shows the results when they are not. The coefficient of MONIT is 0.119 in Column 1, but not significant, and 0.192 in Column 2, significant at the 10% level, consistent with career concerns.
Next, we use the product market competition levels to differentiate between career concerns and quiet life theories. Facing higher product market competition, if the career concerns theory holds, managers may worry about being fired due to poor performance, and they are more likely to allocate firm resources to low-risk projects. Venture capitalists on boards can collect business information, identify the causes of poor business performance, and ease managers’ concerns. Hence, venture capitalists on boards have a positive effect on the innovation of a portfolio company facing more intense product market competition. Therefore, according to the career concern theory, venture capitalists serving as directors have a significant positive impact on corporate innovation. If the quiet life theory holds, in order to maintain their existing position, managers will take the initiative to improve their efforts toward corporate innovation when faced with more intense product market competition. Following Aghion et al. (2013) and Jiang and Yuan (2018), the Lerner index is used to measure a firm’s product market competition. A lower Lerner index indicates high competition intensity. The results are reported in Columns 3 and 4 of Table 7. The coefficient of MONIT is 0.238 in Column 3, which is significant at the 5%, and 0.100 in Column 4, which is not significant. This is consistent with the theory of career concerns.

8. Discussion

The monitoring of venture capital can effectively alleviate the information asymmetry between investors and corporations, which is very important for improving the amount of investment and its duration for investors. Therefore, there are two core issues: monitoring behavior and the mechanism of management behaviors.
First, the research on the monitoring behavior of venture capitalist can be roughly divided into two categories: direct and indirect monitoring. Direct monitoring, according to the research of Burchardt and Kaplan and Strömberg (Burchardt et al. 2016; Kaplan and Strömberg 2003), is mainly carried out to improve voting power and to communicate frequently (Bengtsson and Hsu 2015; Lerner 1995). Indirect monitoring behavior mainly focuses on the proportion of independent directors(Baker and Gompers 2003; Suchard 2009) and executive compensation (Baker and Gompers 2000; Bengtsson and Hand 2013; Kaplan and Strömberg 2004; Sun et al. 2018) or replacing the CEO (Conti and Graham 2020; Ewens and Marx 2018). However, the measurement of monitoring behavior in these studies is very vague, such as the use of new routes, whether venture capital investment is present, and other measures of monitoring behavior. Imprecise measurement may lead to imprecise, and even wrong, conclusions. Our research uses whether a venture capitalist institution sends people to serve as directors of the invested-in corporation to measure the monitoring behavior. We found that venture capitalists on boards can promote corporate innovation. Furthermore, we divided the sample according to the experience of the venture capitalists or the quality of governance of the corporation and found that venture capitalists on boards have a greater impact on corporate innovation when they have high levels of experience or when the corporation has a high quality of governance.
Secondly, according to previous studies on the impact of venture capital monitoring on corporate performance, the default mechanism of managers’ behavior is that managers are rational and risk-averse, and the monitoring of venture capital institutions can increase the punishment of managers’ “laziness”. Furthermore, as managers’ laziness is reduced, their risk-taking level will be improved. However, since Aghion proposed the theories of “career concern” and “quiet life”, it has remained unknown which theory offers a more detailed description of the assumptions made by professional managers in the past. Following Aghion, Bernstein, and Jiang (Aghion et al. 2013; Bernstein 2015; Gormley and Matsa 2016; Jiang and Yuan 2018), we test the career concern theory and quiet life theory to identify which one works best and found that venture capitalists on boards can effectively relieve managers’ worries about their careers. This conclusion is consistent with career concern.

9. Conclusions and Implementation

This study mainly focuses on the impact of the direct monitoring of venture capital on corporate innovation and the specific impact mechanism. We use companies listed in the Shenzhen and Shanghai stock exchanges from 2009 to 2017 as the study sample. Through a series of robustness tests, our conclusion is deemed reliable. We found that venture capitalists on boards play a significant role in promoting corporate innovation. When dividing the sample according to the experience of venture capital or the quality of governance of the corporation, we found that venture capitalists on boards with high levels of experience or in the corporations with high-quality governance have a greater impact on corporate innovation. Furthermore, we studied the monitoring mechanism of venture capitalists on boards and found that the monitoring of venture capital can alleviate managers’ anxiety about being dismissed due to innovation failure.
Our research has some implications for practice, especially for the performance appraisal of professional managers. First, because innovation is a high-risk, highly uncertain investment activity, certain failure tolerance should be given to managers. Following our research, the main reason why venture capital supervision can promote corporate innovation is that venture capital monitoring can alleviate managers’ career anxiety of being fired due to innovation failure. Therefore, corporate innovation can be promoted by improving the tolerance of a manager’s failure. These measures can include longer professional contracts, setting certain failure tolerance clauses, etc. Secondly, from the perspective of venture capital, innovation has the characteristics of high risk and high income. In order to obtain excess investment income, we should strengthen the tolerance of enterprises to innovation failure. Such an improvement in tolerance can be achieved by obtaining more information and better enterprise planning.

Limitations

Although we have tried our best to remedy the potential defects in our methodology, the following research deficiencies persist: Although this study confirms that VCs have a positive effect on the innovation of a portfolio company and we use a variety of methods to test the robustness of this conclusion, there are still some shortcomings. First, although the previous literature used the number of patents as a measure of corporate innovation when studying corporate innovation, this may not measure corporate innovation accurately. A firm’s innovation, processes, and process innovations may be kept secret. Therefore, only using patent data cannot accurately measure a firm’s innovation capability (Tan et al. 2020). Different indicators and more reasonable indicators are thus needed to measure corporate innovation in the future. Second, although this paper uses venture capitalists on boards to measure VC monitoring and this method has been verified, we have not studied how the directors of venture capital affect the behavior of managers, such as their voting power, etc. This may be a direction for further research in the future.

Author Contributions

Conceptualization, H.Z. and L.J.; data curation, L.J.; formal analysis, L.J.; funding acquisition, H.Z. and L.J.; investigation, L.J.; methodology, L.J.; resources, H.Z. and L.J.; software, L.J.; supervision, H.Z.; validation, H.Z. and L.J.; visualization, H.Z.; writing—original draft, L.J.; writing—review and editing, H.Z. and L.J. All authors have read and agreed to the published version of the manuscript.

Funding

This research was funded by the National Natural Science Foundation of China, grant number 72062011.

Data Availability Statement

The data presented in this study are available on request from the corresponding author.

Conflicts of Interest

The authors declare no conflict of interest.

References

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Table
Table 1. Variable definitions.
Table 1. Variable definitions.
VariableDefinition
lnpatThe logarithm of the number of patent applications by corporations to proxy for corporate innovation
monit1 represents the presence of venture capitalists on boards, and zero represents their absence
ageThe logarithm of the difference between the year in which the enterprise was listed and the year in which the enterprise was established
sizeThe logarithm of the total assets of the enterprise
roaReturn on assets
cashThe logarithm of the enterprise has in cash
levAsset–liability ratio
rdLogarithm of one plus firm i’s R&D expenditures
oerRatio of operating cost to operating income
shardThe sum of the shareholding ratio of the top three shareholders
bdnBoard size
ibdProportion of independent directors
Table
Table 2. Descriptive statistics. This table shows descriptive statistics for the variables.
Table 2. Descriptive statistics. This table shows descriptive statistics for the variables.
VariableNMeanSDMinMedianMax
lnpat12533.4771.2140.6933.3146.288
monit12530.3980.585001
age125313.5174.96241237
size125319.610.9417.76219.85124.567
roa12530.960.520.0010.0870.546
cash125318.2370.84215.33218.09721.694
lev12530.5220.2510.0430.4260.826
rd12539.5250.8135.6328.48612.961
oer12530.9320.1910.3640.8541.241
shard125354.23612.81718.01657.11589.850
bdn12539.3241.4255916
ibd12531.4720.050.3000.3330.640
Table
Table 3. Pearson and Spearman correlation matrices.
Table 3. Pearson and Spearman correlation matrices.
lnpatmonit1AgeSizeroacash1levrdoerShardbdnibd
lnpat10.058 *0.124 ***0.237 ***0.0280.202 ***0.083 **0.300 ***0.094 ***0.036 *0.007 *0.030 *
monit10.078 **1−0.0000.060 *−0.071 **0.053−0.0490.056 *−0.023−0.117 ***0.126 ***−0.117 ***
age0.126 ***−0.00410.160 ***0.0130.120 ***−0.063 *0.169 ***0.099 ***−0.067 **−0.0440.078 **
size0.274 ***0.0470.176 ***1−0.317 ***0.633 ***0.475 ***0.659 ***0.379 ***0.0490.171 ***−0.099 ***
roa0.017−0.064 *−0.026−0.260 ***1−0.075 **−0.642 ***−0.104 ***−0.712 ***0.045−0.141 ***0.130 ***
cash10.246 ***0.0470.121 ***0.701 ***−0.01610.141 ***0.552 ***0.148 ***0.0280.123 ***−0.043
lev0.098 ***−0.054−0.0530.469 ***−0.613 ***0.155 ***10.204 ***0.593 ***0.0210.108 ***−0.087 **
rd0.335 ***0.0470.162 ***0.670 ***−0.0380.581 ***0.186 ***10.309 ***−0.0330.116 ***−0.064 *
oer0.123 ***−0.0270.112 ***0.336 ***−0.688 ***0.097 ***0.573 ***0.229 ***1−0.0250.128 ***−0.124 ***
shard30.028−0.101 ***−0.0450.102 ***0.0230.062 *0.0210.007−0.0311−0.162 ***0.110 ***
bdn0.0290.123 ***−0.0300.171 ***−0.120 ***0.147 ***0.092 ***0.114 ***0.098 ***−0.160 ***1−0.715 ***
ibd0.045−0.129 ***0.058 *−0.073 **0.110 ***−0.038−0.067 **−0.034−0.102 ***0.137 ***−0.608 ***1
* Significant at the 10% level. ** Significant at the 5% level. *** Significant at the 1% level.
Table
Table 4. Venture Capitalists on Boards and corporate innovation. This table shows the impact of venture capitalists serving as directors on corporate innovation. Column (1) reports the results with control variable using an ordinary least square (OLS) model and Column (2) contains explanatory variables. Column (3) reports the results using negative binomial regression (NBR).
Table 4. Venture Capitalists on Boards and corporate innovation. This table shows the impact of venture capitalists serving as directors on corporate innovation. Column (1) reports the results with control variable using an ordinary least square (OLS) model and Column (2) contains explanatory variables. Column (3) reports the results using negative binomial regression (NBR).
123
lnpatlnpatpat
monit1 0.145 **0.191 ***
(2.06)(2.98)
age0.011 *0.012 *0.009 *
(1.74)(1.77)(1.81)
size−0.058 **−0.061 *−0.070 *
(−2.60)(−1.63)(−1.78)
roa2.142 **2.463 **2.584 ***
(2.11)(2.40)(2.63)
cash0.142 **0.138 **0.219 ***
(2.25)(2.19)(3.69)
lev0.144 **0.206 **0.241 **
(2.41)(2.58)(2.73)
rd0.329 ***0.329 ***0.330 ***
(5.22)(5.23)(5.64)
oer1.122 **1.217 **1.537 ***
(2.13)(2.31)(3.03)
shard0.102 *0.102 *0.102 *
(1.57)(1.71)(1.84)
bdn0.086 ***0.082 ***0.084 ***
(2.73)(2.60)(3.01)
ibd1.580 *1.681 **1.746 **
(1.87)(1.99)(2.27)
_cons−3.833 ***−4.148 ***−5.320 ***
(−3.82)(−3.90)(−4.76)
indYesYesYes
yearYesYesYes
N125312531253
R20.3240.327
R2_adjust0.2800.283
* Significant at the 10% level. ** Significant at the 5% level. *** Significant at the 1% level.
Table
Table 5. Venture Capitalists on Boards, VC experience, corporate governance, and corporate innovation. This table reports the cross-sectional variation in the effects of venture capitalists serving on boards on corporate innovation across firms with different levels of VC experience and quality of corporate governance.
Table 5. Venture Capitalists on Boards, VC experience, corporate governance, and corporate innovation. This table reports the cross-sectional variation in the effects of venture capitalists serving on boards on corporate innovation across firms with different levels of VC experience and quality of corporate governance.
VC ExperienceGovernance Quality
LowHighHighLow
monit10.1600.249 **0.195 *0.141
(1.26)(2.44)(1.90)(1.38)
age0.022 *0.006 *0.031 **0.012 *
(1.76)(1.83)(1.89)(1.77)
size−0.258 *−0.198 *−0.084 *−0.026 *
(−1.68)(−1.75)(−1.86)(−1.88)
roa2.538 *2.643 **3.774 **1.381
(2.05)(2.16)(2.39)(0.94)
cash0.183 *0.111 *0.087 **0.159
(1.86)(1.84)(1.97)(1.64)
lev0.126 *0.083 *0.263 **0.017 *
(1.91)(1.89)(1.95)(1.73)
rd0.451 ***0.314 ***0.314 ***0.351 ***
(3.86)(3.98)(3.69)(3.47)
oer1.639 **1.494 **1.815 **0.678
(1.98)(2.35)(2.40)(0.84)
shard0.012 **−0.002−0.0030.005
(2.26)(−0.58)(−0.63)(1.15)
bdn0.0780.081 **0.097 **0.082 *
(1.34)(2.08)(2.06)(1.83)
ibd1.8232.026 **3.605 ***0.951
(1.09)(1.99)(2.70)(0.80)
_cons−3.109−4.872 ***−3.280−4.923 **
(−1.15)(−2.86)(−1.59)(−2.39)
indYesYesYesYes
yearYesYesYesYes
N510743619634
R20.3880.3600.3870.328
R2_adjust0.2770.2950.3080.245
* Significant at the 10% level. ** Significant at the 5% level. *** Significant at the 1% level.
Table
Table 6. Robustness checks.
Table 6. Robustness checks.
12345
lnipatlnipatmonit1lnpatlnpat
monit10.283 *** 0.142 **0.145 **
(3.67) (2.02)(2.06)
age0.09 *0.08 *−0.19 *0.023 **0.12 *
(1.93)(1.98)(−1.82)(2.17)(1.67)
size−0.184 **−0.108 *−0.092 *−0.097 **−0.091 *
(−2.06)(−1.91)(−1.66)(−1.97)(−1.63)
roa1.530 *1.434 *−6.675 ***6.866 **2.463 **
(1.97)(1.68)(−4.23)(2.38)(2.40)
cash0.139 **0.149 **0.167 *0.141 *0.138 **
(1.99)(1.98)(1.75)(1.68)(2.19)
lev−0.287 *−0.622 *−1.277 **−0.987 **−1.206 **
(−1.73)(−1.62)(−2.55)(−1.86)(−2.58)
rd0.526 ***0.523 ***−0.0130.318 ***0.329 ***
(7.55)(7.48)(−0.14)(4.87)(5.23)
oer1.210 **1.453 **−2.013 ***2.501 ***1.217 **
(2.36)(2.26)(−2.65)(2.65)(2.31)
shard−0.942 **−0.931 *−0.008 **−0.871 *−0.002 *
(−1.94)(−1.83)(−2.04)(−1.64)(−1.71)
bdn0.076 **0.086 **0.093 **0.029 **0.082 ***
(2.19)(2.46)(2.07)(2.63)(2.60)
ibd1.487 *1.553 **−1.9823.066 **1.681 **
(1.89)(1.94)(−1.60)(2.46)(1.99)
vcif 0.176 **
(2.27)
righot 0.060 *
(1.87)
IMR −0.906
(−1.26)
_cons−3.897 **−3.953 **0.486−3.958 ***−4.048 ***
(−2.82)(−2.54)(0.24)(−2.79)(−2.90)
indYesYesYesYesYes
yearYesYesYesYesYes
N12531253125312531253
R20.2670.262 0.3160.327
R2_adjust0.2190.213 0.2790.283
* Significant at the 10% level. ** Significant at the 5% level. *** Significant at the 1% level.
Table
Table 7. Effect of venture capitalists serving as directors on corporate innovation: Career concerns or quiet life hypothesis. This table reports the cross-sectional variation in the effects of venture capitalists serving as directors on corporate innovation across firms with different levels of managerial entrenchment. We divided the sample into two groups according to whether the CEO is also the chairman of the board of directors. Then, we partition the entire sample into two groups along the median value of the Lerner index.
Table 7. Effect of venture capitalists serving as directors on corporate innovation: Career concerns or quiet life hypothesis. This table reports the cross-sectional variation in the effects of venture capitalists serving as directors on corporate innovation across firms with different levels of managerial entrenchment. We divided the sample into two groups according to whether the CEO is also the chairman of the board of directors. Then, we partition the entire sample into two groups along the median value of the Lerner index.
EntrenchmentLerner Index
Ent = 0Ent = 1LowerHigher
monit10.1190.192 *0.238 **0.100
(1.15)(1.98)(2.47)(1.04)
age0.0490.0540.0880.089
(1.56)(0.44)(1.43)(0.92)
size0.057−0.2790.203−0.444 *
(0.12)(−0.57)(1.31)(−1.87)
roa5.073 **1.3523.272 **1.632
(2.47)(1.25)(2.19)(1.26)
cash0.1860.4380.0420.250 ***
(0.95)(1.47)(0.02)(2.83)
lev0.0570.163−0.6410.482
(0.17)(0.32)(−1.37)(0.96)
rd0.286 **0.592 ***0.250 *0.360 ***
(2.57)(4.59)(1.74)(4.52)
oer2.273 ***0.4961.547 **0.562
(2.82)(0.63)(2.06)(0.49)
shard0.0410.0630.0420.002
(0.19)(0.73)(0.39)(0.52)
bdn0.188 *0.075 *0.096 *0.074 *
(2.22)(1.73)(1.87)(1.79)
ibd2.105 *1.6401.4152.352 **
(1.71)(1.32)(1.03)(2.08)
cons−5.131 **−3.848 *−7.063 ***−1.619
(−2.29)(−1.88)(−3.08)(−0.78)
indYesYesYesYes
yearYesYesYesYes
N626627576677
R20.3120.3940.3200.356
R2_adjust0.2240.3170.2200.283
* Significant at the 10% level. ** Significant at the 5% level. *** Significant at the 1% level.
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Jing, L.; Zhang, H. Venture Capitalists on Boards and Corporate Innovation. J. Risk Financial Manag. 2023, 16, 143. https://doi.org/10.3390/jrfm16030143

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Jing L, Zhang H. Venture Capitalists on Boards and Corporate Innovation. Journal of Risk and Financial Management. 2023; 16(3):143. https://doi.org/10.3390/jrfm16030143

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Jing, Li, and Huiying Zhang. 2023. "Venture Capitalists on Boards and Corporate Innovation" Journal of Risk and Financial Management 16, no. 3: 143. https://doi.org/10.3390/jrfm16030143

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Jing, L., & Zhang, H. (2023). Venture Capitalists on Boards and Corporate Innovation. Journal of Risk and Financial Management, 16(3), 143. https://doi.org/10.3390/jrfm16030143

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