Tolerance for Failure and Corporate Innovation
2014, Review of Financial Studies
Xuan Tian, Tracy Wang
We examine whether tolerance for failure spurs corporate innovation based on a sample of venture capital (VC) backed IPO firms. We develop a novel measure of VC investors’ failure tolerance by examining their willingness to continue investing in underperforming ventures. We find that IPO firms backed by more failure-tolerant VC investors are significantly more innovative, and VC failure tolerance is particularly important for ventures subject to high failure risk. We show that these results are not driven by endogenous matching between failure-tolerant VCs and startups with high ex-ante innovation potentials. We also examine the determinants of the cross-sectional heterogeneity in VC failure tolerance. We find that both capital constraints and career concerns can negatively distort VC failure tolerance. Less experienced VCs are more exposed to these distortions, making them less failure tolerant than more established VCs.
Tian, Xuan and Tracy Wang (2014), "Tolerance for Failure and Corporate Innovation." Review of Financial Studies Vol. 27 (1), 211-255.
tolerance for failure, innovation, patents, venture capital, IPO