What is the role of US venture capital firms in the rise of Indian software and services industries? Are American venture capitalists active in China as well? If a local venture capital industry emerged in Asia, I’d worry about America’s competitive advantage… (Jason Withaker, USA)

US venture capitalists are certainly active in India. Sequoia, one of the leading VCs in the world has only 4 countries on its website, US, China, India and Israel. There are now a large number of Indian venture capitalists also getting into the act. US and local venture capitalists occasionally compete with each other but there is also a lot of cooperation between them. The development of the local venture capital industry can help to expand the market and allow for new opportunities to be funded that might not be funded otherwise.

VC deals are often syndicated, so local VCs might pair up with US VCs. Further there tend to be spillover effects from US VCs coming into the market. Learning of US practices and adoption tends to take place over time. Thus, the contracts between the startup and the VC firm start looking more like the contracts found in the US. And don’t forget that people themselves are very mobile. So you might find partners from a US VC fund joining a local Indian VC or vice versa.

As a financial advisor, I notice that my more optimistic clients are also more risk averse in their financial planning choices. How would you explain this puzzling fact?

My research on optimism suggests that people who are moderate optimists, but not extreme optimists, are more likely to take risks but this is a slightly more nuanced picture than is commonly thought. Moderate optimists have longer planning horizon, they are less likely to smoke, and more likely to give importance to family (in that they are more likely to be married and have a larger number of children). This suggests that while moderate optimists take risks they weigh the risks carefully.

So perhaps you are dealing with moderate optimists who, while willing to take risks, think about them every carefully, but once convinced are willing to take the plunge.

In a recent interview, Jeffrey Immelt, CEO of General Electric, argued that it has become difficult for companies to create shareholder value at a sustained pace. His response has been to push managers to take more risks. In your view, is this a cultural issue related to optimism and risk-taking, or a managerial issue concerning the short-termism of stock markets? (Mariel Honeker, Washington DC, USA)

More than a cultural issue or a short-termism issue, it is an issue of incentives. Managers have a natural tendency to be risk averse because their human and financial capital is tied to the firm. Hence if the firm goes bankrupt, it can take a manager on average 3 years to find a new job, so the incentives for managers to take on risk are low. There may also be some selection going on in that the really big risk takers may not want to work for corporations.

So how do we make managers take on more risk? One way is to compensate them in a way that rewards risk taking, e.g., give more options in their compensation package. The trick is to get the right amount - not too much, not too little - so they take on the “right” amount of risk for the firm.

Commercial banks often underwrite equity issues of companies they lend to. Isn’t this a form of insider trading? (Nicole Polak, Lyon, France)

The question of whether there are adverse effects if banks underwrite securities for firms in which they hold a financial stake, is one that regulators have thought a lot about. In the US the Glass-Steagall Act of 1934 banned commercial banks from underwriting equity securities for the companies that they lend to. After a lot of debate, the Gramm-Leach-Bliley Act of 1999 allowed banks to undertake this activity.

Commercial bank underwriting of securities for companies that it lends to or has equity in can have good or bad effects. Banks may try to “dump” bad issues in the market claiming them to be good and use the proceeds to pay off their loan or to retire their equity. On the other hand because banks have access to private information from their lending/equity stake they may actually be better able to certify the value of the firm giving everyone a fairer picture.

This has been studied extensively by me and others in the US as well as some other countries. Much of the evidence does not support concerns about conflicts of interest. To dig deeper see “Banks in Capital Markets: A Survey”, a paper that I wrote that puts together the literature on this.

I am a Dutch entrepreneur in online services, and I received plenty of support from my bank at all stages of development. I also contacted some venture capitalists, but they invariably asked for the lion’s share of my company capital. So why all this fuzz about venture capital? (Jenke van Daag, Rotterdam, the Netherlands)

VCs claim that they provide not just money but other services too. They help professionalize the firm, hire good outside managers, etc. Some of my research provides evidence that supports this argument see my paper (available as a PDF document): “Venture Capital and the Professionalization of Start-Up Firms: Empirical Evidence”.

Clearly if you do not need these services from the VC and can get the financing from a bank there is no reason to part with a high share of your company. Ultimately VCs focus on a narrow set of companies where their expertise is valuable, but there are many companies where they are not the right investor. Incidentally, studies have shown that VCs, on average, make reasonable returns for the amount of risk that they undertake. So while VCs charge a lot, they take on a lot of risk, which means that many of the companies they back don’t make it.

I am a venture capitalist on Massachusetts’ Route 128. I find that balanced individuals deliver more results than born optimists. Does your research suggest that entrepreneurs are optimists?

Our research suggests that entrepreneurs are optimistic but moderately so, they are not extreme optimists. In our paper (available as a PDF document) “Optimism and Economic Choice” we find that people who are extremely optimistic (e..g., they expect to live 20 years longer than the statistical life tables would predict) tend to make decisions that we would not normally consider prudent. In a subsequent paper we find that, at least in the US data that we study, moderate optimists who have longer planning horizons and tend to make what we might term as reasonable decisions are more likely to be entrepreneurs.

Entrepreneurial companies in Israel flourish despite a semi-permanent state of war. What is your explanation of this? (Edda Hanacek, Warsaw, Poland)

This speaks to the resilience of the Israeli people and their ability to continue in all walks of life despite all that is happening there. You could also look at it in a slightly different way. Israel has many entrepreneurial companies and entrepreneurs tend to be good at dealing with uncertainty and high risk. Part of the reason for the flourishing of entrepreneurship in countries like Israel is that the expatriate community which went out and made it by starting their own firm tend to come back and fund new ventures or help set a positive tone for entrepreneurship. This is documented in other places like Taiwan, and is part of what is happening in Israel and India. Another factor is the active role played by new ventures in innovating for the defense establishment.

Europe’s banking industry is experiencing a strong consolidation process, leading to more efficient organizations. But will “big banks” devote the same attention to average clients and small-to-medium-sized firms as smaller banks did in the past?

Research in the US suggests that big banks tend to cater to big firms, and small banks tend to cater more to small firms. In part this may be because big banks have a longer chain of command and so it is harder to pass “soft” information up the chain whereas small banks might be more easily able to process such information. If this is indeed the reason, it would suggest that if big banks have local centers that are authorized to make the loan decisions, they may be equally able to cater to small and medium size firms. Hence it is not just whether banks are big or small, but how they are structured organizationally.