Product Market Competition and Corporate Venture Capital Investments

Abstract

We study how firms in the information technology (IT) industry respond to product market competition through the use of corporate venture capital (CVC) investments, which are defined as minority equity investments by established firms in start-ups. Using novel measures of product market competition based on product descriptions of firm 10-K statements, this study investigates the impact of product market competition on CVC investments in the U.S. IT industry during the period 1997-2007. We find that firms in competitive markets tend to make more CVC investments and, furthermore, increase the relative magnitude of CVC over internal R&D investments. In addition, CVC investment appears to be an effective way of exploiting external knowledge for firms that are technology leaders in their respective industrial sector but not so for technology laggards. Third, we show that competition plays a less role in explaining CVC investments when firms operate in more uncertain markets. Finally, we show that the text-based network industry classifications are more informative than three digit SIC classifications in explaining CVC decisions. Our results provide insights for theory in innovation and CVC, as well as providing new and novel measures for product market competition.