Journal Article

Tolerance for Failure and Corporate Innovation

Xuan Tian and Tracy Yue Wang

in The Review of Financial Studies

Published on behalf of The Society for Financial Studies

Volume 27, issue 1, pages 211-255
Published in print January 2014 | ISSN: 0893-9454
Published online December 2011 | e-ISSN: 1465-7368 | DOI: https://dx.doi.org/10.1093/rfs/hhr130
Tolerance for Failure and Corporate Innovation

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Based on a sample of venture capital (VC)-backed IPO firms, we examine whether tolerance for failure spurs corporate innovation. 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 that are subject to high failure risk. We show that these results are not driven by endogenous matching between failure-tolerant VC firms and start-ups with high ex ante innovative potential. We also examine the determinants of the cross-sectional heterogeneity in a VC firm's failure tolerance. We find that both capital constraints and career concerns can negatively distort a VC firm's failure tolerance. Less experienced VC firms are more exposed to these distortions, making them less failure tolerant than are more established VC firms.

Keywords: O31; G24; G34

Journal Article.  20264 words.  Illustrated.

Subjects: Technological Change; Research and Development ; Investment Banking ; Mergers and Acquisitions

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