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Researchers Find Venture Capitalists Do Better Investing in Start-Ups Run by Entrepreneurs of Same Ethnicity

June 4, 2014

NYU Stern School of Business professor Deepak Hegde and the University of Munich’s Justin Tumlinson have developed a formal model to understand the “selection” and “influence” effects of social proximity between business partners.

They found that U.S. venture capitalists (VCs) are more likely to select start-ups with coethnic executives (start-up executives with the same ethnic background as the VCs) for investment, particularly when the probability of the start-ups’ success is low.

Coethnic investments perform better, that is, have a higher probability of successful exit through acquisitions and initial public offerings (IPO), resulting in start-ups with higher market capitalization and net income after IPO.

Two-stage regression estimates suggest that these positive performance outcomes are largely due to influence—that is, superior communication and coordination between coethnic VCs and start-up executives after the investment.

The researchers found that to the
extent that VCs expect to work better with co-ethnic start-ups, they invest in coethnic ventures that are of lower observable quality than non-coethnic ventures.

These findings suggest that discrimination toward socially similar others in partnerships can arise from strategic anticipation of superior coordination benefits from socially proximate partners.

The article, “Does Social Proximity Enhance Business Partnerships? Theory and Evidence From Ethnicity’s Role in U.S. Venture Capital,” is forthcoming in the journal Management Science.

 

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