Tax Incentives and the Venture Capital Appetite for Risk

A review of the Kelley-ECGI Lecture ”Tax Incentives and Venture Capital Risk-Taking” by Professor Murillo Campello 5th November 2025.

When policymakers design tax incentives for innovation, the assumption is simple: lower the burden on early-stage firms, and capital will flow to new ideas. But in a recent lecture at the Institute for Corporate Governance and Ethics, Professor Murillo Campello looked one layer deeper. In the U.S., where entrepreneurial finance is shaped not by lone founders but by sophisticated intermediaries, subsidies may do more than stimulate innovation — they may reshape the risk calculus of venture capitalists themselves.

Campello’s analysis, co-authored with Guilherme Junqueira, examines how a major tax programme—the Qualified Small Business Stock (QSBS) subsidy—reshaped investment patterns after its expansion in 2009–10. Blending a structural model with unusually granular data tracing 158,000 investor–firm relationships over twenty years, the study provides a rare empirical window into how fiscal policy interacts with venture capital incentives. The headline finding is striking: enhanced tax benefits push VCs not merely to invest more, but to invest riskier, with consequences visible across firm stages, sectors, and eventual outcomes. 

A Tax Programme with Unusual Power

The QSBS programme is deceptively simple: invest in a qualifying C-corporation (under $50 million in assets, operating in eligible sectors) and, after a five-year holding period, investors may exclude substantial capital gains from taxation. The rules have long existed, but for years the benefit was modest—roughly a 1% reduction in effective capital gains rates when federal rates hovered around 15%. The game changed during the financial crisis, when Congress lifted the exclusion to near-full exemption for qualifying investments. 

Yet unlike other countries, where tax incentives typically go directly to founders, the U.S. market intermediates entrepreneurial finance through venture capital funds, angel investors, and corporate investors. These actors differ sharply in their capital structures, incentive contracts, and exposure to taxes. Venture capital funds, in particular, use outside capital supplied by limited partners (LPs), while general partners (GPs) receive a mix of management fees and “carried interest”—a convex payoff structure that magnifies upside while limiting downside. It is this asymmetry, that makes VCs especially responsive to tax-induced changes in the distribution of returns. 

Why Subsidies Can Shift VC Behaviour

The core theoretical insight of the paper is that VCs face a payoff profile resembling a leveraged call option: LPs supply most of the capital; GPs receive carry on profitable exits; losses are largely borne elsewhere. In such a setup, lowering capital gains taxes—especially through near-complete exemptions—can meaningfully increase the attractiveness of high-variance projects. Angels, by contrast, invest their own capital and earn linear payoffs. As a result, tax changes should have weaker effects on their risk-taking.

Campello’s calibrated model formalises this logic. It predicts that when subsidies increase, VCs should disproportionately favour projects with higher volatility, earlier stages, less information, or weaker monitoring opportunities. Angels should not. Corporate VC arms—taxed on corporate income rather than capital gains—should also remain largely unaffected. These predictions set the stage for the empirical tests. 

Evidence from the Post-2009 Landscape

The study leverages several natural discontinuities: the sudden federal increase in QSBS generosity, variation across industries (eligible vs. ineligible), the $50 million asset threshold, and the five-year holding requirement. Together, these elements allow to isolate behavioural shifts with unusual precision.

1. Exit timing changes.
After the enhancement, qualifying VC-backed firms display pronounced “bunching” exactly at the five-year mark—timed to trigger tax exemptions. Before 2009, the distribution of exits showed no such pattern. 

2. Investment reallocates toward eligible firms.
Using a regression discontinuity at the $50 million asset threshold, Campello shows that firms just below the cutoff received significantly more funding post-reform than similar firms just above it. This shift did not exist before the policy change. 

3. Venture capital risk-taking rises sharply.
The most consequential findings come from a triple-difference analysis isolating risk characteristics of new investments. After 2009, VCs became:

• 74% more likely to fund firms in pre-commercial stages;
• Three times more likely to invest in startups carrying pre-existing debt, increasing their exposure to fiancial risk;
• 16% more likely to invest outside their home state, where monitoring is harder;
• 6% more likely to enter completely new industries;
• 40% more likely to provide the first institutional financing;
• 20% less likely to syndicate their deals, reducing risk-sharing. 

None of these shifts appear among angels or corporate VC arms.

Riskier Bets, Bigger Outcomes

Holding periods matter. When narrowing the sample to investments meeting all QSBS criteria—right industry, right size, and held for at least five years—the consequences become clearer.

VC-backed firms in this group experience:

• 71% higher failure rates,
• double the likelihood of becoming unicorns, and
• twice the average returns among those that exit successfully. 

In short, the subsidy tilts the distribution at both tails: more wipeouts, more home runs, and a steeper payoff structure for investors positioned to capture gains.

Policy Reflections

If tax policy can meaningfully increase venture risk-taking, is this desirable? The paper demonstrates private-sector effects: more innovation, more volatility, more extreme outcomes. But it does not evaluate the counterfactual uses of forgone tax revenue, nor the distribution of welfare gains across society. 

Campello’s lecture offers a powerful reminder: in entrepreneurial ecosystems shaped by intermediaries, policy levers pull through organisational incentives, not just firm-level needs. A subsidy designed to encourage innovation may, in practice, reshape portfolio strategies, governance choices, and the allocation of risk within the financial system.

For policymakers, this is both a warning and a lesson. Tax incentives can indeed stimulate high-variance entrepreneurship—but they do so by altering the behaviour of the institutions entrusted with channeling capital. Understanding these behavioural responses is crucial for designing policies that support innovation while managing its systemic consequences.

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This lecture is part of the Indiana University - ECGI Online Series, a public lecture series on corporate governance. The Kelley School of Business Institute for Corporate Governance (ICG+E), in partnership with Ethical Systems, collaborates with ECGI to deliver this ongoing initiative. As part of this public lecture series, distinguished speakers share insights on the evolving landscape of governance, finance, and market regulation.