Tolerance for Failure and Corporate Innovation

In this paper, we examine whether a failure-tolerant corporate culture spurs corporate innovation and increases firm value based on a sample of venture capital (VC) backed IPO firms. We develop a novel firm-specific measure of a failure-tolerant corporate culture hinging on the idea that the formation of corporate culture is largely determined by the attitudes and beliefs of its founders and early active investors. VC firms are such investors and their attitudes towards failures can have a profound impact on the formation of a failure-tolerant culture in the entrepreneurial firms in which they invest. We find that firms with a more failure-tolerant culture are significantly more innovative. The failure tolerance effect is persistent and robust to controlling for other VC firm characteristics. Further, the failure tolerance effect on firm innovation is stronger in industries in which innovation is more difficult to achieve. We also find opposite roles of insider equity ownership and failure tolerance in motivating innovation. Finally, we find that a failure-tolerant corporate culture increases firm value in industries in which innovation is important. Overall, our findings are consistent with implications in recent theories on corporate innovation that failure tolerance is critical in motivating innovation. Our work also contributes to the literature on corporate culture by making the first attempt at measuring a specific aspect of corporate culture and providing empirical evidence that corporate culture does matter in significant ways for firms’ decisions and performances. TOLERANCE FOR FAILURE AND CORPORATE INNOVATION