Convergence in Venture Capital Investments: Evidence from a Panel of 18 US Regions

By Ballinger, T. Parker; Habegger, Wendy et al. | Journal of Regional Analysis & Policy, May 1, 2016 | Go to article overview

Convergence in Venture Capital Investments: Evidence from a Panel of 18 US Regions


Ballinger, T. Parker, Habegger, Wendy, Jones, Clifton T., Thompson, Mark A., Journal of Regional Analysis & Policy


(ProQuest: ... denotes formulae omitted.)

1. Introduction

There is substantial variation in economic growth across different regions (OECD, 2009). Romer (1986) discusses the role of knowledge creation and hightechnology clustering as a source of economic growth and explains technological progress as an endogenous component to economic growth. As such, this progress comes from directed actions and investment in human capital, which tends to attract venture capital investments (Mathur, 1999). However, limitations on economic resources can result in diminishing returns to productive activities, leading to convergence in economic growth across regions and time (Barro and Sala-i-Martin, 1991; Higgins et al., 2006). Gittell and Sohl (2005) discuss the different policies to promote high-technology centers to encourage regional economic development. These policies work to facilitate entrepreneurial activity and network effects such as supplier relationships and knowledge spillovers that lead to economic development (Shaw, 1997; Chell and Baines, 2000; Gittell and Sohl, 2005). Venture capital is one such area that regional economic developers and policymakers pursue to attract investment in various start-up firms.

Entrepreneurs and start-up firms often need infrastructure investment as well as collaborative partners (i.e., suppliers) that encourage clustering in geographical areas (Feldman, 1999; Samila and Sorenson, 2010). Fostering this type of collaboration of entrepreneurial activity may result in additional venture capital funding opportunities (Chen et al., 2010). However, the concentration of such resources, while necessary, is not sufficient for long-term growth (OECD). The growth opportunities may depend on how such investments are utilized (Sleuwaegen and Boiardi, 2014), the geographic proximity of entrepreneurs seeking such investments, and how venture capitalists are clustered around firms in which they have invested (Chen et al., 2010). Clearly, geography plays an even greater role as venture capitalists tend to take a more active role in the companies in which they invest (Lerner, 1995; Mollica and Zingales, 2007). While these factors highlight the need to acquire capital investments for economic growth, there is still the question of whether such investments in start-up firms vary by region. While investments may vary by region, in order to assist regional economic developers to formulate policy to create opportunities for startups, it is important to understand the market dynamics of venture capital investments.

2. Venture Capital Investment Framework

In order to understand the market dynamics of venture capital investments, we develop a simple reduced-form model of venture capital investments across regions. The basic specification of supply and demand in the venture capital market for a particular region may be represented as:

... (1)

... (2)

where Xs and XD are vectors of exogenous variables that affect the supply and demand for venture capital investments, E(r) is the expected rate of return from such investments, and μ5 and μD are shocks to supply and demand that are assumed to have zero mean and are uncorrelated. Thus, the supply of venture capital depends on the expected return relative to other investments, including other regional venture capital investments. The higher the expected return, the greater investors' willingness to supply capital to entrepreneurial (or start-up) firms. Likewise, the number of firms seeking capital depends on the expected rate of return. As the expected rate of return increases, fewer firms can meet those expectations. A region's equilibrium level of venture capital investments, relative to the nation, can be expressed as:

... (3)

The relative amount of venture capital investments will respond to changes in the exogenous variables that affect both supply and demand in the particular regional market as well as other regions. …

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