Navigating Political Hazard Risks and Legal System Quality

Abstract

With emphasis on a venture’s institutional environment and its stage of development, the authors develop theory to explain how the quality of a nation’s legal system and the level of political hazards affect venture capital (VC) investment strategies in developing countries. The data set consists of 433 VC investment transaction rounds occurring in 13 Latin American countries over the period 1995 to 2003. Different from previous research on the likelihood of investment occurrence, the authors consider the size of an investment transaction as a dependent variable. The authors find a negative relationship between investment size and the political hazards risk and that larger investments are associated with ventures operating in lower quality legal systems. The authors also propose the moderating role of these institutional dimensions in the relationship between a venture’s stage of development and investment size. Findings indicate that in lower quality legal systems, conventional VC-staging strategies are not apparent, where middle and later stage ventures receive the largest investments, but with improvements to the legal system, increasingly larger investments go to early stage ventures. Regarding the stage interaction with political hazards, the authors find that the positive relationship between the venture’s stage of development and investment size weakens as the level of political hazards increases, and when political hazards are high, conventional VC-staging similarly does not occur. In uncovering the unique impact of these institutional dimensions with respect to developing country entrepreneurship, these findings shed light on the acute challenges faced by developing country ventures seeking VC funding at varying stages of development.