"Innovation, Spillovers and Venture Capital Contracts"
Roberta Dessi, Toulouse School of Economics
Abstract:
Innovative start-ups and venture capitalists are highly clustered, benefiting from localized spillovers: Silicon Valley is perhaps the most successful example. There is also substantial geographical variation in venture capital contracts: California contracts are more "incomplete". Could there be a causal link between regional differences in contract design, spillovers, and differences in performance? I explore this possibility, focusing on one observed contractual difference: California contracts typically contain fewer contingencies linking entrepreneurs’ rewards to explicit performance benchmarks. I find that in the presence of significant spillovers, it becomes optimal for innovative start-ups and their financiers to choose such contracts: the 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, generating further spillovers.