Does Reputation Limit Opportunistic Behavior in the VC Industry? Evidence from Litigation against VCs

Abstract

We examine the role of reputation in limiting opportunistic behavior by venture capitalists towards four types of counterparties: entrepreneurs, investors, other VCs, and buyers of VC-backed startups. Using a hand-collected database of lawsuits, we document that more reputable VCs (i.e., VCs that are older, have more deals and funds under management, and syndicate with larger networks of VCs) are less likely to be litigated. We also find that litigated VCs suffer declines in future business relative to matched peers. These declines are larger for more reputable VCs, and for VCs that are defendants to multiple lawsuits or sued by entrepreneurs.

Corporate litigation and executive turnover

“…and other dispositions, respectively. 24 The variable design captures the number of lawsuits filed (Atanasov et al, 2012). Based on the preceding analysis, we expect that CEO and director turnover is more likely to increase following lawsuits that are settled, and less likely to increase following lawsuits that result in court judgment.…”

Shock-Based Causal Inference in Corporate Finance and Accounting Research

“…For examples of our own work using non-shock-based research designs, seeAtanasov et al (2012) (pure observational study of impact of litigation on the reputation of venture capitalists); Black et al (2014) (study, using firm fixed and random effects, of the impact of firm-level corporate governance on firm value in emerging markets). For a skeptical assessment of how strong the clue to causation is, from a "classic panel data" design with firm fixed or random effects, seeNasev et al (2016).…”

The value of ongoing venture capital investment to newly listed firms

“…We control for late stage or growth financing, where LSinv is a dummy variable equal to one if the VC investor is described as providing late stage or growth funding . We proxy for VC reputation using the size of the fund in $US, as larger funds are considered to be more experienced and reputable (Gompers, ; Gompers and Lerner, ; Krishnan et al ., ; Atanasov et al ., ). We include a dummy variable for whether the VC investment was syndicated (that is, there was more than one VC investing in the firm), whether the VC investor has a seat on the board of directors at listing, the number of rounds of financing that the firm received or the amount of VC funding received by the firm.…”