Escalation of commitment in venture capital decision making: Differentiating between domestic and international investors

Abstract

Drawing upon an escalation of commitment framework, this study investigates how differences between cross-border and domestic venture capital investors in emotional, social, and institutional factors affect their decision to terminate an unsuccessful investment. We track the exit outcome of 1060 venture capital investments in 684 European technology companies. Results show that domestic investors have a high tendency to escalate their commitment to a failing course of action, while cross-border investors terminate their investments efficiently, even when investing through a local branch. This is explained by cross-border investors having a lower social and emotional involvement with the project and a lower embeddedness in the local economic and social environment, decreasing individual decision biases. Further, they are affected to a lower extent by normative pressures to further invest from their co-investment network. Local branches of cross-border investors are also shielded from escalation of commitment. We conjecture that their international investment committee acts as an organizational safeguard against individual decision biases. Domestic investors may hence benefit from mimicking the behavior of cross-border investors

Cross-border venture capital investments: The impact of foreignness on returns

“…Bengtsson and Hsu (2015) explicitly note the use of exit success as a limitation of their analysis. 1 Devigne, Manigart, and Wright (2016) highlight that the existing evidence on VC returns at deal level is limited and call for further research in order to understand the variation of returns. We are able to overcome this limitation by using detailed cash-flow data on individual VC investments obtained from the Centre of Private Equity Research (CEPRES) to calculate actual returns on individual VC investments.…”

Venture Capital Internationalization: Synthesis and Future Research Directions

“…This strategy allows the foreign head office to manage challenges that otherwise would require the deployment of expatriates (Pruthi et al ., ). When employing local investment professionals in the branches, cultural and institutional differences are reduced, thereby further facilitating the transfer of knowledge and advice to companies (Pruthi et al ., ; De Prijcker et al ., ; Devigne et al ., ). In the Chinese context, Huang et al .…”

“…Selecting the right investment targets among the deals presented is one of the most important drivers of VC success (Sorensen, 2007). When targeting portfolio companies in a foreign country, a higher geographical and cultural distance and a lower embeddedness in the portfolio companies' environment hampers the transfer of soft information (Devigne et al, 2016). A strategy used by cross-border VC firms to overcome information problems is therefore to select portfolio companies with lower ex ante information asymmetries.…”

“…This strategy allows the foreign head office to manage challenges that otherwise would require the deployment of expatriates (Pruthi et al, 2009). When employing local investment professionals in the branches, cultural and institutional differences are reduced, thereby further facilitating the transfer of knowledge and advice to companies (Pruthi et al, 2009;De Prijcker et al, 2012;Devigne et al, 2016). In the Chinese context, Huang et al (2015) find that having a Chinese office made foreign VCs less likely to syndicate with local VC firms, thereby suggesting that VC firms with a local branch feel they can address liabilities of foreignness by themselves (through the local office).…”

“…Mäkelä and Maula (2006) develop a theoretical model which proposes that if a portfolio company's prospects decrease, a cross-border VC firm's commitment will drop more strongly compared to that of a domestic VC investor. Due to their lower embeddedness in the portfolio company's local environment and lower attachment to the entrepreneur, cross-border VC investors have lower attachments to their portfolio companies, thereby easing the abandonment decision (Devigne et al, 2016). This relationship is magnified with greater geographical distance but mitigated by the relative investment size and the investor's embeddedness in local syndication networks (Mäkelä and Maula, 2006).…”