Navigating Political Hazard Risks and Legal System Quality

Abstract

With emphasis on a venture’s institutional environment and its stage of development, the authors develop theory to explain how the quality of a nation’s legal system and the level of political hazards affect venture capital (VC) investment strategies in developing countries. The data set consists of 433 VC investment transaction rounds occurring in 13 Latin American countries over the period 1995 to 2003. Different from previous research on the likelihood of investment occurrence, the authors consider the size of an investment transaction as a dependent variable. The authors find a negative relationship between investment size and the political hazards risk and that larger investments are associated with ventures operating in lower quality legal systems. The authors also propose the moderating role of these institutional dimensions in the relationship between a venture’s stage of development and investment size. Findings indicate that in lower quality legal systems, conventional VC-staging strategies are not apparent, where middle and later stage ventures receive the largest investments, but with improvements to the legal system, increasingly larger investments go to early stage ventures. Regarding the stage interaction with political hazards, the authors find that the positive relationship between the venture’s stage of development and investment size weakens as the level of political hazards increases, and when political hazards are high, conventional VC-staging similarly does not occur. In uncovering the unique impact of these institutional dimensions with respect to developing country entrepreneurship, these findings shed light on the acute challenges faced by developing country ventures seeking VC funding at varying stages of development.

Institutional Outsiders and Insiders: The Response of Foreign and Domestic Inventors to the Quality of Intellectual Property Rights Protection

“…Domestic inventors typically require a more credible legal system to make investments in developing new knowledge because these firms, especially smaller entrepreneurial enterprises (Khoury et al, 2012), do not have the capability to engage in costly arbitrage between weak IPR systems and the risks they pose (Zhao, 2006). Domestic inventors typically require a more credible legal system to make investments in developing new knowledge because these firms, especially smaller entrepreneurial enterprises (Khoury et al, 2012), do not have the capability to engage in costly arbitrage between weak IPR systems and the risks they pose (Zhao, 2006).…”

“…First, the region-bound country sample offers a natural laboratory for testing the impact of IPR quality on patenting because of the diversity in the adoption of the Paris Convention to improve the quality of IPR protection (Correa, 2000;Gadbaw and Richards, 1988;Watal, 1999). Finally, with few exceptions (Cuervo-Cazurra, 2007, 2008bDau, 2009a, 2009b;Cuervo-Cazurra and Stal, 2011;Dahlman and Frischtak, 1993;Guler and Guillén, 2010;Khoury and Peng, 2011;Khoury et al, 2012;Waguespack et al, 2005), there is a limited understanding of how institutions shape strategies within Latin America and the Caribbean (Nicholls-Nixon et al, 2011). Thus, IPR in particular for these developing countries has been an ongoing issue of international focus.…”

“…In addition to having less knowledge of institutions than domestic actors, foreign actors also interpret institutions differently (Khoury, Junkunc, and Mingo, 2012), even if they are faced with the same objective and observable institutions. Foreign actors, as outsiders, cannot benefit from the knowledge and enforcement properties of the closed networks that are common in developing countries (Yang, 2002).…”

Institutional Frameworks, Venture Capital and the Financing of European New Technology‐based Firms

“…Second, VC investors are diligent monitors of firm performance and can often use termination rights and contractual hostages to further reduce the dependence on national legal frameworks (Abdi & Aulakh, 2012;Khoury et al, 2012). Termination rights entail that VC investors can unilaterally decide to stop providing further (financial) support to their portfolio firms when entrepreneurs do not treat them well.…”

“…This suggests that VC ownership may also influence the relationship between national laws and the financing of firms; but how it will influence this relationship remains unclear. On the one hand, VC investors can compensate for weaker investor protection laws, for instance, by writing extensive contracts that bind entrepreneurs to treat investors well (e.g., Armour & Cumming, 2006;Khoury, Junkunc, & Mingo, 2012). In this case, VC ownership and strong investor protection laws may substitute for one another.…”