Essays on Early-Stage Financing and Firm Behavior

Citation

Chen, Jun (2018) Essays on Early-Stage Financing and Firm Behavior. Dissertation (Ph.D.), California Institute of Technology. doi:10.7907/3mg0-2622. https://resolver.caltech.edu/CaltechTHESIS:05242018-121848007

Abstract

The first chapter of this thesis studies the role of angel finance in the early-stage capital market. Despite anecdotal evidence connecting angel and venture capital (VC) financing, there is little systematic evidence on how the two early-stage capital sources interact. To study this topic, I assemble the first comprehensive dataset on angel financing and characterize its size, scope, and role in the early-stage capital market. I use the population of newly incorporated startups located in California, the largest VC financing state in the United States. Here, the angel capital market is large: approximately 4% of all startups receive angel financing within three years of incorporation. At least five times as many startups receive financing from angels as from VCs in the VC-active industries. Using local individual income as an instrument for angel financing at the zip code level, I show that angels play both supportive and competitive roles in relation to VCs. Angel financing leads to more VC follow-on financing over firms’ life cycles (complement), while it crowds out VC financing from the initial financing round (substitute). My results demonstrate the explicit role of angel financing in the early-stage capital market.

In the second chapter, I develop a game-theoretic model to study information asymmetries in the evolving equity crowdfunding market. I assume (1) there are two types of investors: informed ("insiders") and uninformed ("outsiders"); (2) the insiders invest first; and (3) the outsiders observe the aggregate of insiders' actions and then decide whether to invest. Under these assumptions, I prove that there does not exist a crowdfunding market equilibrium in which the insiders' information is aggregated and high quality startups are funded with higher chances. I then use data from Regulation crowdfunding (Title III equity crowdfunding), and provide evidence that is consistent with the model implications. My results suggest that adverse selection is a primary barrier to equity crowdfunding, and new market designs are required to better develop this market.

The third chapter is joint work with Matt Elliott. We model firms as sets of scarce capabilities, where each capability provides a source of competitive advantage in some markets. Each market is also associated with a set of capabilities that are valued by it. Firm and market hypergraphs represent this information. Our approach provides a new perspective on several industrial organization literatures including merger analysis, strategic alliances and industry dynamics. We argue that merger analysis should be more holistic and that profitable joint ventures increase consumer surplus even when they reduce competition. We also provide formal foundations for a prominent theory of competitive advantage in the management literature.

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