In a new paper, we examine firms’ corporate venture capital (CVC) investing from a disclosure and financial reporting perspective. CVC refers to minority equity investments made by established, publicly-listed firms in privately-held entrepreneurial ventures. CVC investing differs from pure venture capital investing in that strategic gains rather than financial returns are the primary consideration. The investing firm gets access to new sources of innovation and potential acquisition targets, and the startup venture benefits from the established firm’s capital, expertise, and connections. 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 do so as well.
However, critics note several potential drawbacks to CVC investing. Each time there is a market bust, many parent firms pull out of the CVC market, close the startups, and write off the investments. There can also be a conflict of interest regarding whether the CVC subsidiary’s loyalty lies with the “parent” or startup. Startups can be wary of incumbents seeking to gather intelligence to compete against them. The Wall Street Journal recently interviewed more than two dozen entrepreneurs and startup investors who allege that Amazon, parent of its CVC subsidiary Alexa Fund, launched competing products against startups in which Alexa Fund invested in or simply met with. Not coincidentally, the Federal Trade Commission (FTC) began a probe into Amazon and four other large tech firms seeking previously undisclosed information about their past acquisitions, which at the time were too small to trigger antitrust review. The FTC also sought information about the firms’ minority equity investments in startups to assess whether those investments harmed competition and whether disclosure and antitrust review requirements should be broadened. Moreover, a U.S. House antitrust subcommittee released a 450-page report that found, among other things, that several tech firms “surveilled other businesses to identify potential rivals, and have ultimately bought out, copied, or cut off their competitive threats.” The report also proposed to limit these firms’ future acquisitions of, and investments in, startups. These high-profile events underscore the growing desire of regulators and policymakers for more information about firms’ CVC investment activities, even of those previously believed to be too small to matter.
The question of whether publicly-listed firms should disclose more information about their acquisitions and minority equity investments in general, and CVC investments in particular, falls under theories of strategic and voluntary disclosure. Greater disclosure reduces information asymmetry between firm managers and investors, which reduces a firm’s cost of capital. But there are costs to disclosure, including revealing information that would be useful to a firm’s competitors. Proprietary information such as a firm’s investments in innovation and future technologies would appear to be better left undisclosed to competitors for as long as practical, yet firms may want to signal their innovative prowess to investors by voluntarily disclosing selective investments in innovation. The recent scrutiny from regulators and policymakers appears to put the additional pressure on firms with a CVC program to be more transparent and to show that they are not engaging in anticompetitive behavior through their CVC activities. This onus would alter the traditional tradeoff between disclosing information to investors and withholding information from competitors.
Motivated by these recent developments, as well as the growing size of the CVC industry in the past decade, we examine: 1) the types of disclosures that parent firms provide about their CVC activities, 2) factors that explain variation in the detail of disclosures, and 3) how current CVC activities are associated with future acquisitions and acquisition-related financial reporting.
Using hand-collected data from 1996 to 2017 on a comprehensive sample of 115 publicly-listed U.S. parent firms that owned 133 CVC firms, we document that for almost half of the firm-years in our sample, parent firms do not disclose any information about their CVC program. Surprisingly, despite thousands of startups that announce they have received venture financing from the CVC subsidiaries of well-known, publicly-listed firms, most of those investing firms never mention the financing activities in their 10-K or 8-K filings with the Securities and Exchange Commission (SEC), press releases, or corporate websites. 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 variation in firms’ level of disclosure and find that firms disclose less information about their CVC activities when they make investments in industries outside of their core industry, consistent with theories of discretionary disclosure.
We then examine whether having a CVC program is associated with future acquisitive behavior. The rationale is that, if the goal of CVC investing is strategic gain rather than pure financial returns, then one way to achieve that goal is through future acquisitions. Even if future acquisitions are not of CVC investees specifically, an association would suggest that CVC investing may be one element of a firm’s acquisition strategy. We find that relative to control firms without a CVC program, firms with a CVC program make a greater number of acquisitions over future three-year periods. We believe these findings suggest that firms with a CVC program have more awareness of and access to acquirable technologies.
In our next set of analyses, we do not find that parent firms with a CVC program spend significantly more cash for acquisitions or experience increases in goodwill and intangibles than control firms, which suggests that either cash is not the primary form of consideration, the acquisitions are relatively small, or both. However, we do find that parent firms with a CVC program are less likely to record future goodwill asset impairments relative to control firms. This finding suggests that firms with a CVC program are more successful in their acquisitions than their peers without a CVC program.
Lastly, we conduct a small-sample analysis on a subsample of acquisition targets that previously were investees in a CVC portfolio and later acquired by the parent firm. 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 such as the purchase price are sparse. In half of the 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 cases where financial terms and financial reporting implications are disclosed, we find that almost all of the purchase price is allocated to goodwill, other intangibles, and in-process research and development (rather than net tangible assets or liabilities). These findings suggest that most of the acquisitions involve only technology and employees.
Our study contributes to the literature on corporate venture capital from a disclosure perspective. Our study documents the current state of affairs with respect to the amount of publicly available CVC information for a large sample of firms. This serves as an important starting point for regulators and policymakers to conduct an informed debate about whether disclosure requirements should be expanded.
Beyond an examination of CVC disclosures, our study contributes to the prior literature that links CVC investing to future acquisition activity. We note, however, that our study appears to be the first to use a control sample of firms that do not have a CVC subsidiary when making statements about parent firms with a CVC subsidiary. We believe this is an important research design feature that would advance the CVC literature and profession. For example, as we explain in the next section, some CVC professionals claim that a stand-alone CVC subsidiary facilitates better autonomy, talent acquisition, and innovative thinking. However, without counterfactual conditions to compare, such claims cannot be substantiated. Our findings of more future acquisitions and less future goodwill asset write-downs for firms with a CVC subsidiary, compared with control firms without a CVC subsidiary, provides some credence to those beliefs.
Finally, we believe our study’s focus on CVC disclosures is applicable to other settings in which the investing public could benefit from greater transparency. For example, in recent years, interest in Special Purpose Acquisition Companies (SPACs) has exploded. Although SPACs are subject to mandatory filings (S-1 prospectus prior to IPO and 10-Ks, 10-Qs, and 8-Ks after IPO) by the SEC, it is still unclear what types of disclosures are most useful to potential investors, given that a future acquisition target has yet to be identified at the time of the IPO. Even after a target is identified, disclosure levels are typically not on par with traditional IPOs. Accordingly, former SEC Chairman Jay Clayton has expressed concern about the general opacity that SPAC shareholders face and has indicated that the SEC is looking into requiring more disclosure for investors. His concern relates broadly to the opacity and uncertainty surrounding public firms’ investment activities in private companies, which is closely related to our study’s agenda.
This post comes to us from professors Sophia J.W. Hamm at Tulane University’s A. B. Freeman School of Business, Michael J. Jung at the University of Delaware’s Alfred Lerner College of Business and Economics, and Min Park at the University of Kansas School of Business. It is based on their recent article, “Corporate Venture Capital, Disclosure, and Financial Reporting,” available here.