Working Paper: CEPR ID: DP8731
Authors: Roberta Dess
Abstract: Innovative start-ups and venture capitalists are highly clustered, benefiting from localized spillovers: Silicon Valley is perhaps the best example. There is also substantial geographical variation in venture capital contracts: California contracts are more 'incomplete'. This paper explores the economic link between these observations. In the presence of significant spillovers, it becomes optimal for an innovative start-up and its financier to adopt contracts with fewer contingencies: these contracts maximize their ability to extract (part of) the surplus they generate through positive spillovers. This relaxes ex-ante financing constraints and makes it possible to induce higher innovative effort.
Keywords: Incomplete Contracts; Innovation Spillovers; Venture Capital
JEL Codes: D82; D86; G24; L22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| significant positive spillovers (F69) | optimal contracts with fewer contingencies (D86) |
| optimal contracts with fewer contingencies (D86) | higher levels of innovative effort (O36) |
| expectation of surplus extraction (D84) | relax financing constraints (G32) |
| relax financing constraints (G32) | funding of more startups (M13) |
| entrepreneur's effort level (L26) | probability of project success (O22) |
| probability of project success (O22) | expected profitability of subsequent entrants (D43) |
| incomplete contracts (D86) | higher levels of entrepreneurial effort (L26) |
| incomplete contracts (D86) | increased innovation (O35) |