Abstract
This chapter summarizes recent research on the role of law, culture and corruption on venture capital (VC) fund structure, governance and performance. Evidence from studies that involve a multitude of countries is primarily considered. The evidence across most studies is broadly consistent with the view that legal protection enables superior compensation arrangements in limited partnerships where the interests of general partners and limited partners is aligned. More corrupt countries, by contrast, have less efficient compensation structures. The evidence further indicates that better legal systems facilitate contract performance. Finally, the evidence show countries with higher levels of corruption have higher levels of returns, suggesting that fund managers are able to alleviate the effects of corruption in investee companies. In our concluding comments we discuss venture capital around the world and its future development in relation to law, corruption and culture.
This is a preview of subscription content, log in via an institution.
Buying options
Tax calculation will be finalised at checkout
Purchases are for personal use only
Learn about institutional subscriptionsNotes
- 1.
http://www.sjberwin.com/latestpublicationdetails.aspx?title=privateequitycomment; On the political and economic debate see, for example, discussion of the regulation after the mid-2007 financial crisis in The Economist, 19 November 2009, “Europe’s War on Hedge Funds”.
- 2.
We acknowledge that an alternative interpretation of a positive association between corruption and private equity returns could be that private equity fund managers are themselves “corrupt” (i.e. expropriate rents) and able to take advantage of investee firms in more corrupt economies. The empirical tests in Cumming et al. (2010) include a number of transaction specific variables that account for this view.
- 3.
Hofstede’s five dimensions of culture. The dimensions are: Small vs. large power distance, Individualism vs. Collectivism, Masculinity vs. Femininity, Weak vs. strong uncertainty avoidance and Long vs. short term orientation. Power Distance Index (PDI) is the extent to which the less powerful members of organizations and institutions (like the family) accept and expect that power is distributed unequally. This represents inequality (more versus less), but defined from below, not from above. It suggests that a society’s level of inequality is endorsed by the followers as much as by the leaders. Power and inequality, of course, are extremely fundamental facts of any society and anybody with some international experience will be aware that ‘all societies are unequal, but some are more unequal than others’. Individualism (IDV) on the one side versus its opposite, collectivism, is the degree to which individuals are integrated into groups. On the individualist side we find societies in which the ties between individuals are loose: everyone is expected to look after him/herself and his/her immediate family. On the collectivist side, we find societies in which people from birth onwards are integrated into strong, cohesive in-groups, often extended families (with uncles, aunts and grandparents) which continue protecting them in exchange for unquestioning loyalty. The word ‘collectivism’ in this sense has no political meaning: it refers to the group, not to the state. Again, the issue addressed by this dimension is an extremely fundamental one, regarding all societies in the world. Masculinity (MAS) versus its opposite, femininity, refers to the distribution of roles between the genders which is another fundamental issue for any society to which a range of solutions are found. The IBM studies revealed that (a) women’s values differ less among societies than men’s values; (b) men’s values from one country to another contain a dimension from very assertive and competitive and maximally different from women’s values on the one side, to modest and caring and similar to women’s values on the other. The assertive pole has been called ‘masculine’ and the modest, caring pole ‘feminine’. The women in feminine countries have the same modest, caring values as the men; in the masculine countries they are somewhat assertive and competitive, but not as much as the men, so that these countries show a gap between men’s values and women’s values. Uncertainty Avoidance Index (UAI) deals with a society’s tolerance for uncertainty and ambiguity; it ultimately refers to man’s search for Truth. It indicates to what extent a culture programs its members to feel either uncomfortable or comfortable in unstructured situations. Unstructured situations are novel, unknown, surprising, different from usual. Uncertainty avoiding cultures try to minimize the possibility of such situations by strict laws and rules, safety and security measures, and on the philosophical and religious level by a belief in absolute Truth; ‘there can only be one Truth and we have it’. People in uncertainty avoiding countries are also more emotional, and motivated by inner nervous energy. The opposite type, uncertainty accepting cultures, are more tolerant of opinions different from what they are used to; they try to have as few rules as possible, and on the philosophical and religious level they are relativist and allow many currents to flow side by side. People within these cultures are more phlegmatic and contemplative, and not expected by their environment to express emotions. Source: http://www.geert-hofstede.com/
- 4.
Supra note 1.
References
Acemoglu, D., and F. Zilibotti. 1999. Information accumulation in development. Journal of Economic Growth 4: 5–38.
Berkowitz, D., K. Pistor, and J.F. Richard. 2003. Economic development, legality, and the transplant effect. European Economic Review 47: 165–195.
Cao, Jerry, Douglas Cumming, and Meijun Qian. 2010. Creditor rights and LBOs. Available at SSRN: http://ssrn.com/abstract=1086775.
Cressy, R.C. 2002. Introduction: Funding gaps. The Economic Journal 112: F1–F16.
Cressy, R., and H. Farag. 2011. Do private equity firms respond better to financial distress than PLCs? The European Journal of Finance, Vol 18, Issue 3–4, 2012 Special Issue: Law, Ethics, and Finance.
Cressy, R.C., and O. Toivanen. 2001. Is there adverse selection in the credit market? Venture Capital: An International Journal of Entrepreneurial Finance 3: 215–238.
Cressy, Robert, Federico Munari, and Alessandro Malipiero. 2007. Playing to their strengths? Evidence that specialization in the private equity industry confers competitive advantage. Journal of Corporate Finance 13: 647–669.
Cochrane, J. 2005. The risk and return of venture capital, Journal of Financial Economics 75: 3–52.
Cumming, Douglas. 2007. Government policy towards entrepreneurial finance: Innovation investment funds. Journal of Business Venturing 22(2): 193–235.
Cumming, D.J., and S.A. Johan. 2006. Is it the law or the lawyers? Investment fund covenants across countries. European Financial Management 12: 553–574.
Cumming, Douglas, and Sofia Johan. 2007. Socially responsible institutional investment in private equity. Journal of Business Ethics 75: 395–416.
Cumming, D.J., and S.A. Johan. 2009a. Legality and fund manager compensation. Venture Capital: An International Journal of Entrepreneurial Finance 11: 23–54.
Cumming, D.J., and S.A. Johan. 2009b. Venture capital and private equity contracting: An international perspective. San Diego: Elsevier.
Cumming, Douglas, and Uwe Walz. 2010. Private equity returns and disclosure around the world. Journal of International Business Studies 41(4): 727–754.
Cumming, D.J., G. Fleming, and J. Suchard. 2005. Venture capitalist value-added activities, fundraising and drawdowns. Journal of Banking and Finance 29: 295–331.
Cumming, Douglas, Grant Fleming, and Armin Schwienbacher. 2006. Legality and venture capital exits. Journal of Corporate Finance 12: 214–245.
Cumming, Douglas, Donald Siegel, and Mike Wright. 2007. Private equity, leveraged buyouts and governance. Journal of Corporate Finance 13(4): 439–460.
Cumming, D.J., G. Fleming, S. Johan, and M. Takeuchi. 2010. Corruption, legality and buyout returns. Journal of Business Ethics 95: 173–193.
Fleishcher, V. 2008. Two and twenty: Taxing partnership profits in private equity funds. New York University Law Review 83: 1–59.
Gilson, R.J., and D. Schizer. 2003. Venture capital structure: A tax explanation for convertible preferred stock. Harvard Law Review 116: 875–916.
Gompers, P.A., and J. Lerner. 1999. The venture capital cycle. Cambridge: MIT Press.
Hazarika, S., R. Nahjata, and K. Tandon. 2009. Success in global venture capital investing: Do institutional and cultural differences matter? Working paper. New York: Baruch College.
Heckman, J. 1976. The common structure of statistical models of truncation, sample selection, and limited dependent variables and a simple estimator for such models. Annals of Economic and Social Measurement 5: 475–492.
Heckman, J. 1979. Sample selection bias as a specification error. Econometrica 47: 153–161.
Hege, U., F. Palomino, and A. Schwienbacher. 2009. Determinants of venture capital performance: Europe and the United States. Revue Finance 30(1): 7–50.
Jeng, Leslie, and Philippe Wells. 2000. The determinants of venture capital fundraising: Evidence across countries. Journal of Corporate Finance 6: 241–289.
Johan, S., and D. Najar. 2011. The Role of Corruption, Culture, and Law in Investment Fund Manager Fees. Journal of Business Ethics 95: 147–172.
Kanniainen, V., and C. Keuschnigg. 2004. Start-up investment with scarce venture capital support. Journal of Banking and Finance 28: 1935–1959.
Keuschnigg, C. 2004. Taxation of a venture capitalist with a portfolio of firms. Oxford Economic Papers 56: 285–306.
Keuschnigg, C., and S.B. Nielsen. 2001. Public policy for venture capital. International Tax and Public Finance 8: 557–572.
Keuschnigg, C., and S.B. Nielsen. 2003. Taxes and venture capital support. Review of Finance 7: 515–539.
Keuschnigg, C., and S.B. Nielsen. 2004. Start-ups, venture capitalists, and the capital gains tax. Journal of Public Economics 88: 1011–1042.
La Porta, R., F. Lopez-De-Silanes, A. Shleifer, and R. Vishny. 1997. Legal determinants of external finance. Journal of Finance 52: 1131–1150.
La Porta, Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny. 1998. Law and finance. Journal of Political Economy 106(6): 1113–1155.
La Porta, Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny. 2002. Investor protection and corporate valuation. Journal of Finance 57(3): 1147–1170.
Lerner, J., and A. Schoar. 2005. Does legal enforcement affect financial transactions? The contractual channel in private equity. Quarterly Journal of Economics 120(1): 223–246.
Litvak, K. 2004. Governing by exit: Default penalties and walkaway options in venture capital partnership agreements. Willamette Law Review 40: 771–812.
Litvak, K. 2008. Venture capital limited partnership agreements: Understanding compensation arrangements. University of Chicago Law Review 76: 161–218.
Mayer, C., K. Schoors, and Y. Yafeh. 2005. Sources of funds and investment activities of venture capital funds: Evidence from Germany, Israel, Japan and the UK. Journal of Corporate Finance 11: 586–608.
Metrick, A., and A. Yasuda. 2010. The Economics of private equity Funds, Review of financial studies 23: 2303–2341.
Nikoskelainen, Erkki, and Mike Wright. 2007. The impact of corporate governance mechanisms on value increase in leveraged buyouts. Journal of Corporate Finance 13(4): 511–537.
Sahlman, W.A. 1990. The structure and governance of venture capital organizations. Journal of Financial Economics 27: 473–521.
Author information
Authors and Affiliations
Corresponding author
Editor information
Editors and Affiliations
Rights and permissions
Copyright information
© 2013 Springer Science + Business Media Dordrecht.
About this chapter
Cite this chapter
Cumming, D., Fleming, G., Johan, S., Najar, D. (2013). Law and Corruption in Venture Capital and Private Equity. In: Cressy, R., Cumming, D., Mallin, C. (eds) Entrepreneurship, Finance, Governance and Ethics. Advances in Business Ethics Research, vol 3. Springer, Dordrecht. https://doi.org/10.1007/978-94-007-3867-6_5
Download citation
DOI: https://doi.org/10.1007/978-94-007-3867-6_5
Published:
Publisher Name: Springer, Dordrecht
Print ISBN: 978-94-007-3866-9
Online ISBN: 978-94-007-3867-6
eBook Packages: Business and EconomicsEconomics and Finance (R0)