Venture capital: Institutional environment

Abstract

The question asked in this paper is whether overall venture capital (VC) investment (seed, startup, early and later stages) is conditioned by the economic institutional environment as measured by 2 indices of economic freedom (Heritage Foundation’s Index of Economic Freedom, Fraser Institute’s Economic Freedom of the World and their respective partial indices). Panel data analysis of 18 OECD countries over a 6 year period (2001-6) is used. The two indices are compared for consistency. Answer is inconclusive. Both global indices are significantly predictive of VC but with opposite signs. Partial indices also yield results not consistent across the two indices. However, as by-product of this analysis, solid evidence emerges that, first, the size of equity markets positively predicts VC and the link is likely causal and, second, the size of debt markets negatively predicts VC. That is, equity is good but debt is bad for VC. This is a dimension of the institutional environment of VC that is related to private markets and is outside of the scope of the mentioned indices of economic freedom but which turns out to be significant for VC. Takeaway is that attention should be given to development of equity markets, or to facilitating access to international equity markets by national firms, if the goal is to promote VC as a driver of innovation.