Venture Capital Spurs Innovation

"a dollar of venture capital is far more likely to produce patented innovations than a dollar of traditional corporate R and D spending."

The rise of venture capital in the 1980s and 1990s has coincided with a huge wave of innovation and entrepreneurship. It has been widely assumed that there is a causal relationship at work, but empirical research on the relationship has been scant. In Does Venture Capital Spur Innovation? (NBER Working Paper No. 6846) , Samuel Kortum and Josh Lerner attempt to fill this gap by examining the link between venture capital and new patents. They find that a dollar of venture capital is far more likely to produce patented innovations than a dollar of traditional corporate R and D spending. And while this could simply mean that venture-capital-funded companies do not so much innovate more as patent more, other measures of innovation indicate that this is not the case. That is, venture capital does spur innovation.

Kortum and Lerner studied data on 20 manufacturing industries between 1965 and 1992. They found that the amount of venture capital activity in an industry significantly increased its rate of patenting. From 1982 to 1992, in fact, venture capital amounted to just 3 percent of corporate R and D spending, but accounted for 15 percent of industrial innovations.

Kortum and Lerner also compared patenting activity before and after 1979, when a changed Labor Department rule freed pension funds to make big venture investments. This change brought on a sharp increase in venture capital investment. The authors use this regulatory change to help address concerns about the interpretation of the results, in particular concerns that venture capital might follow rather than cause innovations.

Finally, Kortum and Lerner examined data on 530 venture-backed and non-venture-backed firms based in Middlesex County, MA. They confirmed that the venture- backed firms' higher patenting rate coincided with other indicators of innovation, such as how often the firms' patents are cited in other patent applications and how aggressively they litigate to protect trade secrets.

-- Justin Fox

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