Abstract

Despite managing $23 trillion in assets, Development Financial Institutions’ (DFIs) investment activities remain understudied. We document DFIs’ substantial growth in venture capital (VC) investments, now participating as limited partners in one-sixth of all VC deals. We collect the mandates of DFIs and identify four main objectives they pursue through VC investments: building a VC ecosystem, supporting entrepreneurship and small and medium-sized enterprises, fostering innovation, and promoting sustainable business practices. We empirically test whether DFIs meet these objectives by addressing market failures, including externalities, information frictions, and coordination challenges. Our findings vary between developed and developing economies. In developing economies, DFIs are more likely to target industries with positive externalities, provide capital to underrepresented fund managers, and improve return transparency. However, they are less likely than conventional VC investors to support young funds or early-stage deals. Firms backed by DFIs grow similarly to those backed by conventional VCs in terms of profitability, employment, patenting, and sustainability, while having fewer follow-on investments from conventional VCs. In developed economies, we find limited evidence that DFIs address market failures and their impact is more muted. Overall, our findings suggest that DFIs create impact in some aspects but have significant room to enhance their impact by aligning investments with stated mandates and embracing higher risk in their portfolios.

Authors

Aleksandar Andonov, University of Amsterdam & CEPR
Andy Li, University of Amsterdam
Paul Smeets, University of Amsterdam