Moving Beyond the Valley of Death: Regulation and Venture Capital Investments in Early-Stage Biopharmaceutical Firms


ShanghaiTech SEM Working Paper No. 2019-001

Yujin Kim 

ShanghaiTech University

Chirantan Chatterjee

Indian Institute of Management Ahmedabad

Matthew J. Higgins

Georgia Institute of Technology & NBER

Yujin Kim

Venture capitalists (VCs) traditionally invest in risky, early-stage innovations. Recent research suggests, however, that VCs may be herding into less risky, later-stage projects. Such a shift can create funding gaps for early-stage firms. Can regulation reverse this trend by providing information that may reduce the risk of early-stage investments? Using the regulatory setting of the European Union and the passage of the Orphan Drug Act (EU-ODA), we examine this question in the biopharmaceutical industry. We provide causal evidence that VCs are more likely to invest in early-stage biopharmaceutical firms operating in sub-fields disproportionately affected by EU-ODA. We also find that the level of syndication declined for early-stage investments and exit performance improved. Importantly, the shift towards early-stage investment did not lead to any higher proportion of bankruptcies. Collectively, ourresults suggest that the information provided by EU-ODA helped alleviate information asymmetries faced by VCs investing in early-stage biopharmaceutical firms. We conclude by discussing implications for entrepreneurial finance and innovation policy.hanghaiTech University

Keywords: venture capital, biopharmaceutical, investment, valley of death, regulation

Date Written: Ocotober, 2018

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