From venture capital towards venture firm innovation performance: evidence from SMEs of China

2.1. An overview of SMEs

SMEs are not only the source of innovation, but also the source of social economy development [13]. The most significant factors affecting the development of SMEs is the availability of financial resources [14]. SMEs often fail to get enough external financing to support their survival and development, they typically get trapped in the Valley of Death [15].

2.2. Venture capital

VC is considered as an effective way for SMEs to overcome moral hazard [16] and adverse selection [17] compared to other financial intermediaries. With the emergence of VC, SMEs have found a way to free themselves of such dilemmas since VC provides not only several rounds of long-term equity funding that relaxes investment constraints but also provides bundles of value-added activities [18]. VC performs a direct coaching function by spending much time participating in the personnel and strategic management of venture firms, serving as a board member, and working to raise additional funds [19]. Furthermore, VC has expertise and experience in a specific industry and a large network of relationships involving participants, such as customers, professional managers, skilled workers, alliance partners and financial intermediaries [20].

2.3. Firm innovation performance

At the micro level, firm innovation performance has been widely studied to promote firm value and competitiveness [21]. Many recent studies have studied influences of various factors on firm innovation performance such as relationships between institutional investor and firm innovation performance [22], network structure and firm innovation performance [23]. Firm innovation performance has been conceptualized and measured both from the perspectives of technology and commercialization. From the perspective of technology, indicators such as patent applications [24], and forward citation-weighted patent counts [25] are two of the most widely used indicators to measure firm innovation performance. From the perspective of commercialization, some other indicators such as total factor productivity (TFP) [26] and the product innovations [27] have also been used to measure firm innovation performance.

2.4. Management incentives

There are two basic type of management incentives (MI): management cash incentive (MCI) and management equity incentives (MEI) [28]. Numerous studies have found that VC-backed firms outperform their non-VC-backed counterparts on management incentives, to achieve good reputation and rapid exit strategy [29]. While existing literature has not yet reached consensus on the relationship between management incentives and firm innovation performance. Numerous studies have implied that management incentive is the key factor for improving firm innovation performance by mitigate principal-agent conflicts [30]. In contrast, the entrenchment effect holds that management incentives lead to managerial opportunism behavior and reduce firm performance [31].

3.1. Venture capital and firm innovation performance

VC plays a direct coaching function by spending significant time participating in the personnel and strategic management of venture firm, serving as board members, and working to raise additional funds [32]. Furthermore, VC has the expertise and experience of a specific industry and a large network of relationships involving participants such as customers, professional managers, skilled workers, alliance partners and financial intermediaries [33]. VC also provides venture firm numerous indirect benefits like the imprint effect to third parties [34]. Moreover, some studies have shown that VC change venture firm’s management strategy from innovating to the commercialization of innovation [11]. VC’s role is more to help the commercialization of innovation rather than to foster innovation [35]. Based on the above, the following hypotheses are proposed:

H1a: From the perspective of technology, VC has a positive impact on venture firm innovation performance.

H1b: From the perspective of commercialization, VC has a positive impact on venture firm innovation performance.

3.2. Mediating role of management incentives

Jensen and Meckling [36] proposed that managers are more likely to be concerned with private interests. When the objectives of VC and entrepreneurs are inconsistent or divergent, VC needs to more carefully monitor venture firms to achieve their goals [37]. Firstly, according to grandstanding hypothesis, VC attaches great importance to its own reputation, and intends improve management incentives to reduce agent costs, promote their work motivation. Secondly, compared with business founders, VC, as a short-term investor, aims for the maximization of short-term returns. VC expects to establish a valuable impression of the venture firm to other potential investors by improving management incentives, encouraging the Lake Wobegon Effect, and attracting more external talents to join in [29]. Hence, we infer that both management cash incentives and equity incentives play mediating roles in the relationship between VC and venture firm innovation performance. Based on the above, the following hypotheses are proposed:

H2a: Management cash incentives mediates the relationship between VC and venture firm innovation.

H2b: Management equity incentives mediates the relationship between VC and venture firm innovation.

4.1 Data and sample

To appropriately test our hypotheses, we started with a sample of enterprises listed on the SME board of China. Considerable manual work was done to extract complicated data from the widely used commercial databases WIND and CSMAR. We gathered a sample of enterprises listed on the SME board of China from the time period 2008 –2017, a total of 927 SMEs; altogether 3,895 data were obtained.

4.2. Dependent, independent and control variables

From the perspective of technology, the number of patent applications and the patent count is widely used to measure a firm innovation [35]. Consist of previous studies, we chose Patents, as the cumulative number, effectively represented the patents were still under protection. From the perspective of commercialization, TFP also reflects firm innovation performance [26], we also chose TFP as the other dependent variable by which firm innovation performance was measured.

In most research, a dummy variable VC dummy is widely used as an independent variable which switches from 0 to 1, taking the value 1 if a firm receives VC, and 0 otherwise. We also included VC as the independent variable standing for the shareholding ratio of VCs in the first 10 largest shareholders of each firm per year [38]. Following Yu and Lin et al. [39], the mediating variables reflecting management incentives were measured by MCI and MEI. MCI was measured as the logarithm of the average cash compensation of venture firm’s senior managers, directors and supervisors per year, including salary, bonus and other incomes. MEI was measured as the shareholding percentage of venture firm’s senior managers, directors, and supervisors per year.

Six control variables that may influence venture firm innovation performance were included in our analysis: LnAsset, Ratio, Age, Location, Industry and Year. Following the recommendation of Colombo and D’Adda et al. [40], we controlled for venture firm size (LnAsset), measured by the logarithm of a total asset to avoid the effects of multiple size-dependent measures. We also included Ratio [41], using the debt-to-asset ratio, to reflect the risk and management situation. Following Park and Steensma [42], Age was also included and calculated as the number of years since venture firm founded. Since the available resources might be different in different time and affect the venture firm innovation activity in prior research [11, 35], this paper also used Year, Industry and Location as control variables.

4.3. Econometric model

The causal steps introduced by Baron and Kenny [43]. First, we used the following models 1–2 to test our hypotheses to validate H1a and H1b, examining the relationship between VC and venture firm innovation.

Patent i , t = β 0 + β 1 VC i , t + β 2 LnAsset i , t + β 3 Ratio i , t + β 4 Age i , t + β 5 Industry i , t + β 6 Location i , t + β 7 Year i , t + ɛ i , t(1)

TPF i , t = β 0 + β 1 VC i , t + β 2 LnAsset i , t + β 3 Ratio i , t + β 4 Age i , t + β 5 Industry i , t + β 6 Location i , t + β 7 Year i , t + ɛ i , t(2)

Further, we tested the significance of the regression coefficient between the VC and the meditation variables (MCI and MEI), as shown in Models 3–4. MCI i , t = β 0 + β 1 VC i , t + β 2 LnAsset i , t + β 3 Ratio i , t + β 4 Age i , t + β 5 Industry i , t + β 6 Location i , t + β 7 Year i , t + ɛ i , t(3) MEI i , t = β 0 + β 1 VC i , t + β 2 LnAsset i , t + β 3 Ratio i , t + β 4 Age i , t + β 5 Industry i , t + β 6 Location i , t + β 7 Year i , t + ɛ i , t(4)

Finally, we tested the regression coefficients of the VC, meditation variables (MCI and MEI) and the dependent variables (Patents and TFP) by adding the meditation variables to Models 1–2.

Tables 1, 2 shows the descriptive statistics and correlation matrix of the main variables. Table 2 demonstrates that all correlation coefficients between the independent variables and control variables were less than 0.5, excluding the effects of multicolli-nearity.

5.1. VC’s effect on venture firm innovation performance

As shown in Table 3, Hausman test was conducted to rule out this issue, demonstrating that the fixed effects models were unbiased and consistent. Table 3 reports the effects of VC on firm innovation performance and the mediating effects of management incentives. Column (1) shows a significant negative effect of VC on patent (β=–0.0284, t=–2.15); Column (2) shows a significant positive effect of VC on TFP (β=0.0368, t = 2.97). Therefore, H1b was supported while H1a was rejected. Results show a significant negative effect of VC on the Patent and a significant positive effect of VC on the TFP of venture firm.

We provided empirical evidence of the negative impact of VC on venture firm innovation and the negative impact of VC on venture firm innovation. These results demonstrate that VCs in China do not focus on nurturing innovation but devoted much to commercialization of new technology, illustrating some specific characteristics like making fast money [44]. Our finding is in line with the view of short-termism, it is impossible for ventures to share all information with VCs, resulting in VCs mainly pursue short-term return and lack of their long-term cooperation.

In Table 3, column (3) shows a positive relationship between VC and MCI (β=0.1829, t = 3.18), indicating that the MCI of VC-backed firms are higher than non-VC-backed firms; columns (4) shows a positive relationship between VC and MEI (β=0.2172, t = 3.16), indicating that the MEI of VC-backed firms are higher than non-VC-backed firms. In columns (5) and (6), MCI (β=–0.0534, t=–1.38) and MEI (β=–0.1295, t=–1.12) do not show a significant relationship with the Patent of investee firm, demonstrating that both MCI and MEI do not exhibit a mediating effect between VC and patent. In columns (7) and (8), MCI (β=0.0494, t = 3.26) and MEI (β=0.0902, t = 3.14) both show a significant positive relationship with the TFP of investee firm, implying that both MCI and MEI mediate the relationship between VC and the TFP of investee firm. H2a and H2b were rejected, while H2a and H2b were confirmed.

From the perspective of commercialization, we showed that both MCI and MEI had a partial mediating effect on both VC and firm innovation performance. Our finding indicates that VC promotes firm innovation performance directly or indirectly (through MCI and MEI), suggesting that VC affect MCI and MEI, in turn, influence venture firm innovation performance. These results implying that higher MCI and MEI can reduce agent cost, improve the enthusiasm of management and firm innovation performance [45]. While, from the perspective of technology, higher MCI and MEI could not promote innovation. MCI and MEI do not have a mediation effect between VC and Patent. This can be attributed to China’s immature corporate governance mechanisms, which emphasizes much more on short-term benefits, not ignores long-term benefits and competitiveness [46].