An Instrumental Variable Approach to Uncover the Status Dynamics in the U.S. Venture Capital Industry

This paper tries to answer how a firm can grow its status by disentangling the effect of status in the past from the effect of time-varying ability to grow in status. An instrumental variable approach is an effective means to handle endogeneity problem, but the application is limited due to an un-testable exclusion restriction. This paper introduces an instrumental variable approach based on the plausibly exogeneity assumption and applies it to the U.S. venture capital dataset. By applying the “plausibly exogenous” approach, this paper shows that even under violations of exclusion restriction, the unemployment rate can serve as a valid instrument for complementary status, which signals quality as a co-investor. The finding suggests that complementary status positively affects future primary status, which signals quality as a lead investor, net of its effect through improving the firm’s ability to grow in primary status.