Abstract

Venture capital (VC) investors face a liquidation dilemma when portfolio companies (PCs) underperform: they may either further finance the PC to keep the option of improvement or terminate it, which entails certain losses (Tversky & Kahneman, 1992). Prior research has shown that VCs escalate their commitment to a failing course of action (Guler, 2007). We argue that escalation of commitment is more prevalent when domestic VCs (DVCs) invest, compared to cross-border VCs (CBVCs). The smaller geographical and cultural distances DVCs face, result in lower transaction costs and higher emotional attachment (Mäkelä & Maula, 2005; Guiso et al., 2006, 2007, 2008; Bottazzi et al., 2008). Moreover, lower costs and difficulties to acquire and process reliable soft information on PCs and local market conditions increase the DVCs’ probability to escalate commitment as they will focus more on soft information, use less high-powered contracts and apply lower hurdle rates compared to CBVCs (Bengtsson & Ravid, 2009; Chen et al., 2010). The goal of this study is to empirically investigate the probability of escalation of commitment by DVCs as compared to CBVCs.

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