Cost of Experimentation and the Evolution of Venture Capital

Michael  Ewens; Ramana  Nanda; Matthew  Rhodes-Kropf

Article | Journal of Financial Economics | June 2018

Cost of Experimentation and the Evolution of Venture Capital

by Michael Ewens, Ramana Nanda and Matthew Rhodes-Kropf

Abstract

We study how technological shocks to the cost of starting new businesses have led the venture capital model to adapt in fundamental ways over the prior decade. We both document and provide a framework to understand the changes in the investment strategy of VCs in recent years—an increased prevalence of a "spray and pray" investment approach—where investors provide a little funding and limited governance to an increased number of startups that they are more likely to abandon, but where initial experiments significantly inform beliefs about the future potential of the venture. This adaptation and related entry by new financial intermediaries has led to a disproportionate rise in innovations where information on future prospects is revealed quickly and cheaply and has reduced the relative share of innovation in complex technologies where initial experiments cost more and reveal less.

Keywords: innovation; venture capital; Investing; abandonment option; Technological Innovation; Venture Capital; Investment;

Format: Print

51 pages

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Citation:

Ewens, Michael, Ramana Nanda, and Matthew Rhodes-Kropf. "Cost of Experimentation and the Evolution of Venture Capital." Journal of Financial Economics 128, no. 3 (June 2018): 422–442.

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Cost of Experimentation and the Evolution of Venture Capital

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