3The Venture Capital Cycle. Paul A. Gompers and Jose Lerner. The MIT Press, Cambridge, Massachusetts

The Venture Capital Cycle. Paul A. Gompers and Josh Lerner. Cambridge, MA: The MIT Press, 2000, 384 pp. ISBN 0-262-07194-0.This book is a major publishing event in the venture capital literature. Professors Gompers and Lerner, both of Harvard Business School, have for some years made distinguished contributions to the research literature on venture capital in leading academic journals. This book aims to bind together their previously published work into a coherent whole. What results is a durable piece of high-quality capital equipment, which acade-mics, graduate business students, and quantita-tively inclined practitioners will want to draw upon again and again.In structure, the book is a set of ten previously published papers, grouped under the three main headings of venture capital fundraising, venture capital investing, and exiting from venture capital investments. It is this trinity, fundraising, investing, and exiting, which constitutes “the venture capital cycle” of the title. It is an excel-lent organizing device for the volume as a whole. Each of the three sections has a new “overview”chapter. Add to this an introductory chapter, a chapter length “note” on data sources, and a concluding chapter on the future of the venture capital industry, and you have this new book.As regards its content, this book has no major surprises. Readers who have avidly collected the mimeo versions of papers by the authors, and who have followed through by doing their homework on the emerging literature in the journals, will have encountered much of the content of the book before. However, the whole is more than the sum of its parts, because the authors bring out the relationship between their various published works rather successfully. Further, the three “overview”chapters, the introduction and the conclusion, are all well written. They are of a simpler style than the other chapters, and provide a new and acces-sible entree to the venture capital literature.The key ideas of the book are identified by the authors as: incentive and information problems; venture capital as a process over time, rather than a one-off involvement; and lags in adjustment in the supply of and demand for venture capital funds. Given the importance of the work, it is reviewed in detail below.Quantitative methods are used extensively in the book, and this can be a valuable source of pedagogic illustrations, as well as a solid body of scientific work of interest to specialists. Generally, descriptive statistics back up the early parts of each argument, often supported by graphs, line diagrams and sometimes three dimensional diagrams. Typically, this is done extraordinarily well. All of this will be an inspiration to students contemplating projects on honors or masters courses, for which this volume provides a superb mentoring example. Although practitioners too will enjoy, and learn much from, the quantitative work.When it comes to econometrics, however, the grasp of the authors is a little less secure. In many cases, a more detailed approach could have been adopted in their reporting on econometric models. One often felt that a more discerning approach to hypothesis testing would also have been desirable. For example, in the important fourth chapter, on venture capital compensation, a linear model is considered for explaining relative value of an IPO in terms of date of closing, size of venture capital organization, and venture capitalists’ percentage of profit. Three modeling alternatives are pre-sented, OLS, Tobit and 2SLS, though arguably the OLS results should have been dropped. It is found that in none of the specifications is there a significant link between compensation and per-formance. However, in the case of these models, the probability values are 0.744, 0.255 and 0.757 respectively. In other words, it is not just the compensation variable that is not working, it is the modeling itself.There is some evidence, however (in the Tobit),Book ReviewsSmall Business Economics15: 73–78, 2000.that size is positively related to performance. Does it make a difference if a quadratic (or even cubic) size variable is used? One feels a slight uneasiness in reaching so rapidly the conclusion expressed. How was heteroskedasticity dealt with (indeed, was it considered), for example? Was an attempt made to explore interactions between the inde-pendent variables? Were tests of robustness employed? It may well be that all this was con-sidered, but it is not mentioned, though the use of other variables is alluded to. Because of this lack of richness in the discussion, here and elsewhere, of the applied econometrics, one feels some results may not be entirely stable.A recurring worry for me was the tendency for the authors to treat probit estimation as just another type of linear regression. This is rather a dangerous way to proceed, as coefficients in probits cannot be interpreted in the same way as coefficients in linear regressions. In particular, it is desirable to compute Hensher-Johnson weighted elasticities to assist in interpreting probits. Finally, one was also uneasy that so many of the models reported, quite often for large sample sizes (e.g. several hundred observations) with many regres-sors (e.g. from half a dozen to a dozen) had extremely low goodness of fit measure (e.g. Tables 4.2, 4.6, 7.6, 7.7, 7.8, 13.3, 14.8). Thus, for many of these regressions, the percentage explained variation could often be as low as a few percent. True, such regressions may be significant on an F test, but for large samples, and more than half a dozen regressors, the relevant critical values for F-distributed variates can be as low as two (or less) for conventional levels of significance. Though the models are undoubtedly picking up something, and inferences are technically correct, there is much left unexplained.Considered from a literary point of view, the style is by no means always accessible. One example, which relates to a test of a crucial claim concerning public offering, runs as follows: “This claim is tested by examining the time from the receipt of the original S-1 statement by the SEC to the effective date of the IPO. The filing date is found in SDC’s Corporate New Issues database (1992). When it is not available from this source, the date of the ‘received’ stamp on the original S-1 filing is used” (p. 232). Though this is, in a sense, scientifically accurate, the style does not encourage “dipping into” the text, as so much is assumed, in terms of technical background knowl-edge of the venture capital industry and its data sources.The above example is descriptive. A more analytical one is “A one-standard deviation reduc-tion in the Carter-Manaster ranking of the book under-writer (i.e. by 1.1 rank) led to a predicted event window return of –2.8 percent”. If you read each of the above examples carefully, and in its context, the reasoning is indeed correct, but there is still a communication failure along the line. A final example is “Results in panel A of Table 14.2 present equal-weighted, buy-and-hold cohort results versus the NYSE/AMEX equal-weighted index” (p. 300). This kind of “explanation” occurs sufficiently frequently that one feels the authors have perhaps too great an affection for the extensive jargon of the financial world and the financial economist. I do not think any scientific damage is done by this, but it certainly may limit the accessibility of the volume. An important antidote to this aspect of the book is therefore the set of “overview” chapters, which should be the first port of call for readers who wish to be rapidly assimilated into the main lines of argument.The above are all matters of professional detail, which should not put off the potential reader. After all, much of this material has already passed stringent criteria of peer review. It is now up to those who follow on, to attempt the difficult task of improving on the work of these two authorities. Currently there is no published volume that rivals Gompers and Lerner in terms of scope and depth. Most venture capital books are strongly practi-tioner based, and this is one of the few that is solidly grounded in academia.Venture Capital at the Crossroads(Harvard Business School Press, 1992) by Bill Bygrave and Jeff Timmons is more accessible and popular in style and content, but less scientifically ambitious. It is quantitative in orientation, but deploys few inferential techniques. Qualitative evidence is never handled formally, but only used for examples. It is not heavily organized around themes in terms of treatment of subject matter, but is more a mosaic of venture capital topics. My own Venture Capital Investment(Routledge, 1998) is deliberately narrower in focus, reporting on a single project, which emphasized field work74Book Reviews。