How important is innovation for venture capitalists’ (VCs’) market reputation?

• I link a VC's focus on relatively safe projects (expected diversification) to the Nahata (2009) measure of market reputation.
• I show a VC's focus on relatively innovative projects (unexpected innovation) is a measure of market reputation.
• The Nahata (2009) market reputation measure does not convey the information contained in unexpected innovation.
• Unexpected innovation yields the highest estimates of idiosyncratic ability relative to other reputation metrics.
• Unexpected innovation introduces convexity into venture capitalists’ reputation functions.

I find empirical evidence that venture capitalists’ (VCs’) principals reward unanticipated or unexpected improvements in VCs’ ability to deliver relatively innovative ventures to market with market reputation. I also find the combination of a focus on innovation and exits via third party acquisitions yields the best risk-return trade-offs, and is associated with the highest estimates of idiosyncratic ability within the cross-section of the venture capital market. These findings provide evidence that a focus on innovation is associated with ability and rewarded with market reputation within the venture capital market. Given I find IPO exit rates are not measures of unanticipated improvements in VCs’ ability to deliver relatively innovative ventures to market, the market reputation channel in this study differs from but is complementary to the IPO channel motivated in Nahata (2009).