Same rules, different results: human capital and venture capital emergence under institutional voids

Prior research suggests that venture capital (VC) markets rely on formal institutions to mitigate agency risks and transaction costs, and in their absence, informal institutions often step in to fill these institutional voids. Yet, despite similar institutional configurations across many emerging economies, thriving formal VC markets emerge in some but not in others, raising questions about the substitution hypothesis. To address this puzzle, we develop a framework that integrates human capital theory with an institutional perspective, arguing that formal and informal networking institutions are insufficient to explain VC market development in the absence of adequate market sophistication. To illustrate and validate this framework, we conducted 45 interviews across Pakistan’s VC ecosystem, a context characterized by weak formal institutions and strong informal networking institutions. We find that limited sophistication among regulatory, fund management, and entrepreneurial actors constrains participation in the formal VC market, confining less sophisticated actors to informal financing channels and sustaining their reliance on them. Our framework reconciles the persistence of thriving informal financing markets alongside underdeveloped formal VC markets . We recommend targeted policy interventions to enhance inclusion in formal VC market by strengthening entrepreneurial and VC-specific capabilities.