Venture Fraud
We assemble the first comprehensive sample of fraud cases involving 633 U.S. venture capital (VC)-backed startups that raised on average $47 million by the time of fraud detection. Using a sample of newly public firms involved in class action suits to align detection rates, we first show that VC-backed firms are more likely to commit fraud than non-VC-backed firms. This difference is particularly pronounced after 2010, coincident with a rise in founder-friendliness in the VC market. In a panel prediction model covering all venture fraud cases in pre-IPO startups, we find that proxies for agency frictions strongly predict fraud, while founder characteristics matter much less. Fraud is more likely in startups with strong founder control rights and weak yet more convex founder cash flow rights. It also rises with coordination frictions among investors and the presence of non-traditional investors. Hot funding conditions at the initial round predict future fraud. Fraudulent entrepreneurs continue to found new VC-backed firms unharmed relative to non-fraudulent entrepreneurs, suggesting a lack of market discipline. Overall, our results highlight rising agency costs in VC-backed firms and suggest that a founder-friendly VC market may lead to misallocation and broader social costs.
Ting Xu
Ting Xu is an Assistant Professor of Finance at the University of Toronto, Rotman School of Management, and a Faculty Research Fellow at the National Bureau of Economic Research. He was previously an Assistant Professor at the University of Virginia, Darden School of Business. His research focuses on entrepreneurial finance, innovation, labor and productivity. His work has been published in leading academic journals, such as the Journal of Finance, the Review of Financial Studies, the Journal of Financial Economics. His research has been cited in news outlets such as the Bloomberg, NPR, and BBC, and by regulators at the SEC, FINRA, IFRS, BLS, and US state legislatives. He teaches Fintech and Financial Management to MBA students at Rotman, where he received the Rotman Teaching Award. Ting Xu holds a PhD in Finance from the University of British Columbia.