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Divestment, Entrepreneurial Incentives, and the Life Cycle of the Firm

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  • Wolf Wagner

Abstract

An entrepreneur who wants to divest his firm suffers a time‐inconsistency problem: divesting a stake creates an incentive to divest further since he does not internalize the arising agency costs for the stake already sold. This paper shows that this leads to excessive divestment in equilibrium and entails efficiency losses which can offset any potential divestment gains. As a result, firms may stay private even if there are large gains from going public. We show that venture capitalists can reduce these inefficiencies. This is because they have influence over a firm's divestment decisions and can distinguish between an excessive and a desirable dilution of equity (such as in response to liquidity shocks). We also show that the divestment inefficiency gives rise to an optimal time of going public, which trades off the gains from going public early (higher divestment gains) with its costs (higher divestment inefficiency).

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  • Wolf Wagner, 2010. "Divestment, Entrepreneurial Incentives, and the Life Cycle of the Firm," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 37(5‐6), pages 591-611, June.
    • Handle: RePEc:bla:jbfnac:v:37:y:2010:i:5-6:p:591-611
    DOI: 10.1111/j.1468-5957.2010.02184.x
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    Cited by:

    1. Bock, Carolin & Schmidt, Maximilian, 2015. "Should I stay, or should I go? – How fund dynamics influence venture capital exit decisions," Review of Financial Economics, Elsevier, vol. 27(C), pages 68-82.
    2. Carolin Bock & Maximilian Schmidt, 2015. "Should I stay, or should I go? – How fund dynamics influence venture capital exit decisions," Review of Financial Economics, John Wiley & Sons, vol. 27(1), pages 68-82, November.

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