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A Soft Budget Constraint Explanation for the Venture Capital Cycle

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  • Georg Gebhardt

Abstract

. We explore why venture capital funds limit the amount of capital they raise and do not reinvest the proceeds. This structure is puzzling because it leads to a succession of several funds financing each new venture, which multiplies the well‐known agency problems. We argue that an inside investor cannot provide a hard budget constraint while a less informed outsider can. Therefore, the venture capitalist delegates the continuation decision to the outsider by ex ante restricting the amount of capital he has under management. The soft budget constraint problem becomes the more important the higher the entrepreneur's private benefits are and the higher the probability of failure of a project is.

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  • Georg Gebhardt, 2009. "A Soft Budget Constraint Explanation for the Venture Capital Cycle," German Economic Review, Verein für Socialpolitik, vol. 10(1), pages 71-90, February.
    • Handle: RePEc:bla:germec:v:10:y:2009:i:1:p:71-90
    DOI: 10.1111/j.1468-0475.2008.00442.x
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    References listed on IDEAS

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    Cited by:

    1. János Kornai, 2014. "The soft budget constraint," Acta Oeconomica, Akadémiai Kiadó, Hungary, vol. 64(supplemen), pages 25-79, November.
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    4. Ma, Yu & Zhang, Tingting & Qian, Wenyu & Wei, Danqi, 2022. "Financial development, demographic changes, and the growth of the non-hydro renewable energy Industry—An empirical test based on R&D and financing costs," Renewable Energy, Elsevier, vol. 185(C), pages 217-229.

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