DP8731 Innovation, Spillovers and Venture Capital Contracts

Author(s): Roberta Dessí
Publication Date: January 2012
Keyword(s): incomplete contracts, innovation, spillovers, venture capital
JEL(s): D82, D86, G24, L22
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=8731

Innovative start-ups and venture capitalists are highly clustered, benefiting from localized spillovers: Silicon Valley is perhaps the best example. There is also substantial geographical variation in venture capital contracts: California contracts are more 'incomplete'. This paper explores the economic link between these observations. In the presence of significant spillovers, it becomes optimal for an innovative start-up and its financier to adopt contracts with fewer contingencies: these contracts maximize their ability to extract (part of) the surplus they generate through positive spillovers. This relaxes ex-ante financing constraints and makes it possible to induce higher innovative effort.