Venture Capital Influence on Innovation : A Fund - Level Perspective

This paper investigates the dynamic relationship between the finite duration of the VC fund and the exploratory nature of innovation pursued by the portfolio ventures and whether the relationship is contingent on fund performance relative to its expected performance (reference point). The paper draws on the theoretical framework of exploration-exploitation and provides an illustrative two-arm bandit model to analyze the investment tradeoff between exploration of uncertain innovation that may generate higher innovation impact and exploitation of known innovation. The empirical analysis based on VC-backed biotechnology ventures provide evidence that VCs invest in more exploration type innovation at the start of fund that generate a higher innovation impact but progressively the degree of exploration and the innovation impact declines over the finite duration of the fund. However, when the fund performance falls below expectations, VCs exhibit risk seeking behavior and continue to pursue exploration projects that generate a higher innovation impact.