Their interests tend to diverge in the later stages, write Haemin Dennis Park and Daniel Tzabba

Park, Dennis

Tzabbar, Daniel

LSE Research Online

6/14/2016The power play between venture capitalists and CEOsshapes startup innovationblogs.lse.ac.uk /businessreview/2016/06/14/the-power-play-between-venture-capitalists-and-ceos-shapes-startup-innovation/Our research explores how venture capitalists (VCs) and chief executive officers (CEOs) jointly affect the risk-takingbehaviour of a startup — manifested through innovation novelty over the new venture’s different life stages. Weshow that VCs behave differently for each stage. They generally encourage startups to take high risk by pursuingnovel innovations early on. In later stages, VCs tend to encourage less risky, more incremental, innovations. This isbecause VCs are typically sitting on potential profits that they do not want to risk losing in a more mature newventure.However, this tendency is strengthened or attenuated depending on the power dynamics between VCs and thestartup’s CEO. We consider two sources of power that CEOs can rely on. One is their structural power, or thenumber of job titles they hold. This source of power gives them the ability to influence the agenda of a new ventureby controlling its information flow and decision making. CEOs with structural power also tend to be more optimisticand future-oriented due to their perceived job security. We argue and show that startups led by CEOs with highstructural power are likely to strengthen the positive effect of VCs in pursuing risky, novel innovations in the earlystages and attenuate the negative effect of VCs in pursuing less risky, incremental innovations in the later stages.Another source of power for startup CEOs stems from their prior experience with inventing activities, or what wecall “expert power”. We argue and show that startups led by expert CEOs take a more balanced approach toinnovation-related activities given their experience with inventing activities. As such, they are likely to attenuate theinfluence of VCs in encouraging the startups to pursue risky, novel innovations early on, to appropriately balancerisk and outcomes during this stage. Likewise, startups led by expert CEOs are also more prone to attenuating theVCs’ influence in pursuing less risky, incremental innovations in later stages.Our research was conducted based on a sample of 482 biotech firms in the U.S. that received VC funding between1973 and 2003. Biotechnology is at the intersection of molecular biology, immunology, genetics, and chemistry. Theintegration of this new set of technologies has the potential to transform various fields – pharmaceuticals, chemicals,1/2agriculture, veterinary science, medicine and waste disposal. These transformational opportunities joined withintense competition for patentable know-how creates incentives for startups to generate novel innovation. Wemeasure innovation novelty at different stages of a startup by looking into whether the patents it filed follow theconventional knowledge structure of similar patents or deviate from that. Deviation would indicate that startups mightbe pursuing risky, novel recombination of different types of knowledge that have not been recombined before.Our study sheds new light on the VC-CEO relationship and provides insights into how the risk preference and theabilities of mutually dependent actors affect the innovation outcomes of new ventures. The findings of this studycould help VCs and startups to choose the best CEO depending on their objective – and provide insights on howmuch power to assign to the CEO.Moreover, startup founders can also gain new insights on the potential benefits and costs in receiving VC funding.Furthermore, our study underscores the need for a better alignment between the incentives of various stakeholdersin privately held entrepreneurial firms, particularly in their late stages. Indeed, although the interests of VCs and theirinvestees are aligned in their early stages, their interests diverge later on, and the conflicts may be exacerbated asVCs plan to exit their involvement. Entrepreneurs should be wary of these potential conflicting interests with VCs.♣♣♣Notes:This post is based on the authors’ paper Venture Capital, CEOs’ Sources of Power, and Innovation Novelty atDifferent Life Stages of a New Venture, Organization Science 27(2):336-353. The post gives the views of its authors, not the position of LSE Business Review or the London School ofEconomics.Featured image credit: Apps for Europe CC-BY-2.0Before commenting, please read our Comment PolicyHaemin Dennis Park is an Assistant Professor of Management at the LeBow College of Business,Drexel University. He received his PhD from the Foster School of Business, University ofWashington. His research examines how external resource acquisition strategy of new ventures inhigh tech industries affect their development and performance. Daniel Tzabbar is an Associate Professor of Strategy, at LeBow college of Business, DrexelUniversity. He received his PhD from Rotman School of Management, University of Toronto.His research focuses on creating and testing organizational and strategic theories related to themechanisms that facilitate learning and technological change. His work highlights the micro-mechanisms associated with human capital as a key driver of these transformations. Byintegrating human capital theory with knowledge-based view and power theories, his researchprovides a theoretical and empirical meeting ground for economists, organizational theorists, andstrategic human capital scholars. His work has been published in premier outlets such as,Academy of Management Journal, Strategic Management Journal, Organization Science andJournal of Management, where he also serves as an editorial board member. Copyright © 2015 London School of Economics2/2

The power play between venture capitalists and CEOs shapes startup innovation

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