Venture capital as an innovation ecosystem engineer in an emerging market

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Highlights

  • VC firms play a different and more proactive role in emerging markets as an “ecosystem engineer”.

  • They do so through governing the resource flow and selecting deviation, driving regional innovation performance.

  • Such effects are stronger in the presence of multinational enterprises (MNEs) in the region.

  • Such effects persist and increase over time, whereas the MNE moderating effects decline.

  • These hypotheses are supported by a Chinese provincial-level panel data (1999–2010).

Abstract

How can venture capital (VC) firms transform a weak innovation ecosystem into a productive and robust one? While the literature has found VC firms’ catalyst role in innovation in developed markets, we know little about whether and how they affect innovation in an emerging market, where formal institutions (e.g., regulations and markets) and informal institutions (e.g., professional networks) to enable VC firms’ catalyst role are relatively lacking. First, we argue that VC firms play a different and more proactive role in these markets as an “ecosystem engineer” through governing the resource flow and selecting deviation, which drive regional innovation performance. Second, such effects are further positively moderated by the presence of multinational enterprises (MNEs) in a region. Lastly, over time, while the direct effects of VC firms persist and increase, the moderating effects of MNE presence decline. Empirically, we examined a Chinese provincial-level panel data of VC activities (1999–2009) and patent applications (2000–2010) and found supportive evidence. Implications are discussed.

Introduction

How does a weak innovation ecosystem evolve into a productive and robust one? As an emerging perspective in the innovation research, the ecosystem perspective seeks to answer this question by focusing on the formal and informal institutional contexts that shape entrepreneurial innovation (Autio, Kenney, Mustar, Siegel, & Wright, 2014; Autio & Thomas, 2014). Some recent promising research focusing on this perspective include platform architecture and governance (Tiwana, 2013), innovation networks (Dodgson, Mathews, Kastelle, & Hu, 2008), entrepreneurial narratives (Garud, Gehman, & Giuliani, 2014), business deaths (Hechavarria & Ingram, 2014), bottom-up entrepreneur (Davis, 2012), institutional adaptability (Dodgson, 2009), and national innovation system (Intarakumnerd, Chairatana, & Tangchitpiboon, 2002; Kanter, 2012), amongst many others. Although this emerging perspective coincides with the rising interest in the entrepreneurship and innovation literature on evolutions and adaptability (Murmann, 2013), we know little about the evolutionary process of the ecosystem, especially the roles played by major actors such as venture capital (VC) firms and multinational enterprises (MNEs) and their interactions in the dynamics of the innovation ecosystem.

In this study we try to explore some answers to these questions using an “ecosystem engineer” metaphor, a concept borrowed from ecology. In an ecological system, an ecosystem engineer is an organism that has the ability to modulate the resource flows and to modify and create new habitats of other organisms. For example, beavers can build ponds by damming streams and then increase the number and diversity of other species who rely on water resources (Jones, Lawton, & Shachak, 1994; Wright, Jones, & Flecker, 2002). Following Boxenbaum and Rouleau (2011)’s way of developing new theory from metaphor, we argue that venture capital (VC) firms, relatively recently introduced into emerging markets, generate a similar effect on the evolution of their regional innovation ecosystem.

The literature in innovation and entrepreneurship has widely documented that in developed markets VCs have been an important catalyst in innovation activities (Haarmeyer, 2008; Lerner, 2012; Samila & Sorenson, 2010). Specifically, through their patient capital, financial incentives such as options, and advisory services, VCs motivate local entrepreneurs to focus on risky technological development (Ding, Sun, & Au, 2014; Ferrary & Granovetter, 2009; Kortum & Lerner, 2000; Lerner, 2012). Their impact on local innovation activities is facilitated by established legal- and economic institutions and a rich network of professional intermediaries in these developed markets, including strong property rights- and legal regimes in which equity transfer contracts are clearly defined and strongly enforced, efficient and liquid capital markets in which VC firms can exit formally, and a varieties of professional service providers who help startups with their financial, legal, and managerial expertise (Cumming, Siegel, & Wright, 2007). However, VCs’ role in regional innovation in an emerging market context is relatively unclear (Ahlstrom, Bruton, & Yeh, 2007), because all the facilitating institutions and intermediaries mentioned above are relatively lacking or under-developed. Notably, property-rights regimes and rule of law are weakly enforced; both stock- and private capital markets are relatively thin and illiquid (Khanna, Palepu, and Sinha, 2005); and professional intermediaries such as law- and accounting firms and investment banks are still limited (Khanna et al., 2005).

In this study, we argue that in an emerging market VCs play a role as an ecosystem engineer (Jones et al., 1994), which is more proactive than only a catalyst as that in a developed market. This ecosystem-engineer role contains two major functions, governing resource flows and selecting deviation. Specifically, VCs govern flows of such resources as capital, information, managerial knowledge through decision rights in their invested ventures, control mechanisms, and incentive schema (Tiwana, 2013). They also target high-growth opportunities and select promising startups as a way to deviate the characteristics and performance of local entrepreneurs in the same innovation ecosystem (McKelvey, 2002; Volberda & Lewin, 2003). In the process of creating and evolving the innovation ecosystem, VCs also interact with other business organizations who share similar institutional logics towards investment and innovation, notably multinational enterprises (MNEs), especially both are constrained by institution voids in emerging markets. The co-existence of VCs and MNEs in the same region reinforces each other in their attempts at filling institutional voids and complements VCs’ capability of governing resource flows and selecting deviation. However, over time, as VC-invested startups build up their technology, know-how, and proprietary innovation capacity, becoming new competitors with MNEs, who traditionally rely on technology and know-how to compensate their liability of foreignness (Rein, 2014; Tse, 2015). This increasing competition would reduce complementing effects between VCs and MNEs. Since innovation activities tend to be clustered and concentrated into different regions, we focus on the regional level to study such innovation ecosystem (Carlsson, Jacobsson, Holmén, & Rickne, 2002). Empirically, we test our hypotheses using a Chinese provincial-level panel data of VC activities (1999–2009) and patent applications (2000–2010). The results show significant support to our main hypotheses. In this paper, we operationalize the concept of an ecosystem engineer in the context of interactions between venture capital and related actors within a region. Namely an agent modulates resource flow into and within a spatial region which enables symbiotic relationships between existing members of the focal region, in a way in which the existing actor groups, such as firms, are selected to deviate their stock of knowledge and ability; and results in increased survival, over time and in relation to other actor groups within the region. Although borrowed from the natural sciences, we elaborate its contextual meaning in our application to managerial and social sciences, through a sociological ecosystems host theory.

This study makes three theoretical contributions. First, we find that VCs play the role of ecosystem engineer to make an inefficient ecosystem in innovation into a productive one. Our ecosystem engineer metaphor provides an “emergent meaning” (Cornelissen, 2005: 758) in which we borrow findings and theories from ecology to explain the dynamics of innovation activities. Second, we argue for an external variation-selection-retention process over the trajectory of interactions between organizations, while the previous literature mostly focuses on internal variation within one organization or industry (Volberda & Lewin, 2003). These findings enrich our understanding of the ecosystem dynamics and value creation in innovation (Autio & Thomas, 2014). Third, the current literature suggests that emerging markets are a unique and under-explored institutional context to examine the dynamics of innovation ecosystems (Autio et al., 2014; Garud et al., 2014). As the context which regulates entrepreneurial innovation has received little attention, this study allows us to see organizations and their interactions in a new light. That is, one species group engineers an ecosystem which increases survival fit, select deviations of some species (local firms), while being symbiotic with others (MNEs) – an interaction that changes over time. Practitioner insights in understanding VC activities and industry specific innovation, MNE strategic alliance, amongst others, can be gleaned from such a conceptualization of ongoing topics. Other uses of such a metaphor may inform current and future public policies regarding barriers to entry of foreign capital, placing more focus on the intended regional outcome. This paper aims to fill this gap by focusing on the largest emerging market, China, where both VC activities and innovation have seen fast growth in the last decade, which itself provides an interesting contextual setting.

Section snippets

A fragmented innovation ecosystem in emerging markets

From the ecosystem perspective, emerging markets are fragmented in encouraging innovation activities because of its under-developed factor- and product markets and innovation-supporting environments, including legal- and economic institutions and lack of professional business intermediaries (Khanna et al., 2005; Thomas & Autio, 2014). Emerging markets are characterized by weak property-rights regimes, corrupt legal-political governance, and market failures (Peng, 2001). These weak institutions

Sample

We select China, the largest emerging market in the world, as our empirical setting for several reasons. China’s first wave of VCs emerged hand-in-hand with the global dot-com boom in the late 1990s. This first generation of Chinese technopreneurs has stimulated numerous high-tech- or Internet-focused startups both in China and abroad. Some VC-invested firms, including Sina, Sohu, and Netease, successfully completed the VC exist by listing on NASDAQ (Ahlstrom et al., 2007; Bruton & Ahlstrom,

Findings

Table 1 gives the definition and summary statistics of the dependent variables and explanatory variables discussed in this section. Table 2 lists the correlations among all the variables. It seems that some variables are highly correlated. We then test the variance inflation factor (VIF) score for every regression model. None of them are higher than 10, suggesting that these correlations do not cause multi-collinearity issue and bias of the estimations (Greene, 2003).

Table 3 reports the

Discussion

Different from the catalyst role played by VCs in developed markets, VCs play a more proactive role as an ecosystem engineer to create and transform the variation-selection-retention dynamics of innovation ecosystem in an emerging market context, where the supporting institutions and professional intermediaries are relatively lacking and the innovation ecosystem is inefficient. In extant work on the topic, due to a disproportionate focus on developed contexts, this catalyst narrative VCs

Conclusion

Ecosystem engineers are important players in transforming the dynamics and landscapes of an ecological system. Beavers could carry mud and stones to build ponds overnight. These ponds not only protect beavers from predators but also offer nurseries for salmon and trout and help to restore wetlands. VCs dependence on institutional support in developed market contexts is widespread in academic management literature. However, how this role of a catalyst in innovation changes within developing

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