How Transparent are Firms about their Corporate Venture Capital Investments?

Corporate venture capital (CVC) refers to direct minority equity investments made by established, publicly-traded firms in privately-held entrepreneurial ventures. CVC investing differs from pure venture capital investing in that financial returns are not the primary consideration, but rather, strategic gains are often the driving motivation to invest. While established firms in the technology, industrial, and healthcare sectors such as Google, General Electric, and Johnson & Johnson have set up CVC subsidiaries to invest billions of dollars in startups, younger firms such as Twitter with relatively smaller cash balances are starting to engage in venture capital investing as well. According to data from CB Insights, firms’ CVC investments in the U.S. were $17.9B in 2015 and $16.1B in 2016, involving 1,603 deals that accounted for nearly one-fifth of overall venture capital deals. CVC investments are now at the highest levels since the dot com era. The motivating research questions we are interested in examining in this setting are: 1) how transparent are firms about their CVC investments, and 2) is CVC investing a productive use of a firm’s capital resources?

We operationalize our research questions by examining firms’ voluntary disclosures about their CVC subsidiaries, their acquisition behaviors, and the financial reporting implications related to CVC investment activities. While CVC investing has been the subject of several studies in the management literature, there has been little to no research on how CVC investing is related to the aforementioned constructs typically examined in the accounting literature. We address this gap in the literature by using hand-collected data on a comprehensive sample of 115 publicly-traded “parent” firms that owned 133 CVC firms between 1996 to 2017 to examine: 1) the initial decision to sponsor a CVC program, 2) variation in the amount of disclosures provided by parent firms that sponsor a CVC program, 3) future acquisition behavior and financial reporting implications, and 4) financial details of a subsample of acquisitions of targets that previously were investees in a CVC portfolio.

In our first analysis, we examine the determinants of firms owning or sponsoring a CVC program. Using measures of firms’ research and development (R&D) spending, capital expenditures, changes in external financing, and cash and short-term investment positions, we predict and find that firms with larger cash and short-term investment positions are more likely to own or sponsor a CVC program, compared to a group of control firms without a CVC program. We also find that firms with higher R&D spending are more likely to sponsor a CVC program, suggesting that CVC investing is a complementary (rather than substitutionary) action to a firm’s internal R&D program.

Next, we document that for more than half of the firm-years in our sample, the parent firms do not disclose any information about their CVC program. Surprisingly, despite thousands of startups that announce receiving venture financing from the CVC subsidiaries of well-known, publicly-traded firms, most of those investing firms never mention the financing activities in their 10-K and 8-K filings with the Securities and Exchange Commission (SEC). Among the parent firms that do disclose their CVC activities, there is much time-series and cross-sectional variation in the amount and detail of disclosures. We test for the determinants of firms’ level of disclosure and find that firms disclose more information about their CVC activities when dedicated institutional ownership is lower, transient institutional ownership is higher, and industry competition is lower, consistent with prior studies on the factors that influence firms’ voluntary disclosure decisions. Our results also suggest that firms are more forthcoming with information when the amounts invested in the CVC portfolio are higher, but not when the investments are made in ventures outside of the parent firm’s core industry, which we conjecture is due to concerns about competition.

In our third set of analyses, we examine whether having a CVC program is associated with future acquisitive behavior. We find that relative to control firms without a CVC program, firms with a CVC program make a greater number of acquisitions over the next three years. We do not find that these firms spend more cash outlays for acquisitions than control firms, but they do acquire more goodwill and intangible assets; this result suggests that many of the acquisitions are financed with the acquirer’s stock. This type of scenario can lead to potential impairment charges if the acquisitions manifest from a dysfunctional investment strategy using overpriced stock, and therefore, we also test whether having a CVC program is related to proxies of future acquisition success and failure. We find that future sales contribution from acquisitions is higher for firms with a CVC program, while we do not find that they have higher future goodwill impairment charges. These results suggest that a parent firm having a CVC program tends to have more potential acquisition targets to consider, and among the acquisitions that are made, there is a higher likelihood for increased sales but not a higher likelihood for failure as measured by future asset write-downs.

Lastly, we analyze a subsample of acquisition targets that previously were investees in a CVC portfolio and later acquired by the parent firm. Our intent is to more closely examine the details of the initial CVC investment and subsequent acquisition to shed additional light on the voluntary disclosure and financial reporting implications. We find that, on average, the parent firm of the CVC subsidiary acquired the target two to three years after an initial CVC investment. However, disclosures of financial terms are sparse. In the majority of cases, one cannot determine the amount of the initial CVC investment prior to the acquisition and also cannot infer that amount after the acquisition. Among the few cases where financial terms and financial reporting implications are disclosed, we find that 98 percent of the purchase price is allocated to goodwill, other intangibles, and acquired in-process research and development, while 2 percent is allocated to net tangible assets. These findings suggest that most of the acquisitions involve only technology and employees, and they corroborate our previous result suggesting that having a CVC subsidiary is associated with future buildups in goodwill and intangibles.

One of the primary contributions of our study is that it brings attention to the fact that despite billions of dollars of capital invested in early-stage startups by well-known, widely-held public firms, there is very little disclosure about the investing activities. For several decades, corporate venture capital investing has generally been a veiled allocation of capital. Our findings are consistent with theories of voluntary disclosure that suggest firms withhold details of their corporate venture capital activities for concerns about competition. However, even after firms announce an acquisition and reveal that the target firm had been a part of its CVC portfolio, most firms do not disclose financial terms, which prevents investors from fully assessing the financial and accounting implications of a firm’s CVC program on an aggregate or individual deal level. A lack of disclosure may also suggest that the CVC investments are less favorable than what shareholders of the investing firm would expect, which has been shown in prior studies on disclosures of business combinations. This evidence can inform regulators and standard-setters on whether firms should be more transparent in their corporate venture capital activities.

The complete paper is available for download here.