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Moral hazard in high-risk environments: optimal follow-on investing in venture capital finance

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  • Julius Tennert
  • Marie Lambert
  • Hans-Peter Burghof

Abstract

This paper examines the joint effect of environmental risk and moral hazard on staging activity in venture capital financing. We show theoretically and empirically that venture capitalists face a trade-off between (a) deferring and staging investments to engage in learning of the risky venture and avoid downside losses and (b) committing additional funds to update the incentive of the entrepreneur. We describe this trade-off through the timing of follow-on investments and show that highly qualified entrepreneurs demand greater compensation (a larger share) than do less-qualified entrepreneurs in situations of high risk.

Suggested Citation

  • Julius Tennert & Marie Lambert & Hans-Peter Burghof, 2018. "Moral hazard in high-risk environments: optimal follow-on investing in venture capital finance," Venture Capital, Taylor & Francis Journals, vol. 20(4), pages 323-338, October.
    • Handle: RePEc:taf:veecee:v:20:y:2018:i:4:p:323-338
    DOI: 10.1080/13691066.2018.1491095
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    Cited by:

    1. Donia Trabelsi & Baran Siyahhan, 2021. "Startup cash flows and venture capital investments: A real options approach," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 42(3), pages 737-750, April.
    2. Harrison, Richard T. & Bock, Adam J. & Gregson, Geoff, 2020. "Stairway to heaven? rethinking angel investment policy and practice," Journal of Business Venturing Insights, Elsevier, vol. 14(C).

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