The change in the business model of venture capitalists from investing locally towards investing across borders started to intensify in the late 1990s. Compared to domestic investments, cross-border investments are likely to be associated with higher transaction and information costs. The reason for this is that venture capital is typically invested in opaque risky ventures where information asymmetries between the entrepreneurs and the venture capitalists are particularly pronounced and which therefore require intensive pre-investment screening, post-investment hands-on management support and control. Nevertheless, there are at least two potential benefits that might outweigh the higher costs of investing across borders. By crossing borders, venture capitalists are able to exploit return differences between their home country and the portfolio companiesï¿½ countries. But even if return differences were absent, venture capitalists might invest abroad in order to diversify their portfolios geographically and to reduce their country-specific risks. In this paper we study the economic determinants of cross-border and domestic venture capital investments. A better understanding of the determinants behind domestic and cross-border venture capital investments is interesting to academics as well as to policy makers since cross-border venture capital inflows may compensate for potential limits in the domestic venture capital supply. We use a European and North-American country dataset and start by simultaneously analyzing how economic determinants shape domestic venture capital investments (i.e., when the venture capitalist is located in the same country as the portfolio company) and gross cross-border venture capital inflows (i.e., when the venture capitalist is located outside the country under focus). We find that countries with higher patent counts have a higher number of domestic investments as well as gross cross-border inflows than countries with lower patent counts. Countries with higher expected economic growth have a higher number of gross cross-border inflows than countries with low growth prospects. In addition, countries with viable stock markets have more domestic investments and are more successful in attracting investments from foreign venture capitalists than countries with unviable stock markets. We continue by investigating whether venture capital inflows compensate for potential limits in the domestic venture capital supply and analyze net cross-border venture capital inflows for country pairs. We define net cross-border inflows as the gross cross-border inflows attracted by the i-country portfolio companies from the k-country venture capitalists minus the gross cross-border outflows, which i-country venture capitalists invest into k-country portfolio companies. Our results indicate that countries with higher expected growth and lagged stock market returns receive larger net cross-border inflows. Moreover, a higher stock market capitalization and a more favorable environment for venture capital intermediation lead to lower net cross-border inflows. These finding may indicate that venture capitalists located in countries with viable stock markets can raise funds at more favorable conditions and venture capitalists located in countries with attractive tax and legal environments for venture capital intermediation have incentives to invest their funds in jurisdictions with less favorable tax and legal conditions. Thus, net cross-border inflows compensate limits in the local venture capital supply.
Tykvova, Tereza and Andrea Schertler (2012), What Lures Cross-Border Venture Capital Inflows?, Journal of International Money and Finance 31 , 1777-1799