Tunneling When Venture Capitalists are Distracted

Using the regulation-induced initial public offering (IPO) suspensions in China as shocks that distract venture capitalists (VCs) from their other portfolio companies because they must pay attention to the suspended firms, we identify the reduced impact of their monitoring role on other portfolio companies. These IPO suspensions increase intercorporate loans and the probability of capital occupation violation by 0.5 and 11.4 percentage points, respectively, for the treated portfolio companies. The suspension effect is more (less) pronounced for companies with a larger (smaller) extent of distracted VCs, companies experiencing more (less) problematic tunneling, and companies with looser (tighter) alternative governance mechanisms. Our large-scale survey also identifies a decrease in the interactions between VCs and portfolio companies