Abstract

This paper utilizes a natural experiment - the establishment of the Shenzhen Small and Medium Enterprises Board (SME Board) - as an exogenous shock of liquidity provision to venture capital (VC) investment in China. The establishing of the SME Board has enabled the disentangling of the supply side from the demand side of entrepreneurial financing. The results show that the establishment of the SME Board had a strong positive impact on VC investment activities. The impact, however, occurs mainly through the supply side channel, in the form of an influx of first-time VC funds and new government-sponsored VC funds. Such supply shocks, created by inexperienced - but politically connected - VCs, tend to overheat the VC market in the short-run. The results are robust against various regression specifications and endogeneity concerns. This research highlights the importance of liquidity provision, institutional factors and government policies on the development of entrepreneurial financing.