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Venture Capital Financing, Moral Hazard and Learning

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Author Info
Bergemann, Dirk
Hege, Ulrich

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Abstract

We consider the provision of venture capital in a dynamic agency model. The value of the venture project is initially uncertain and more information arrives by developing the project. The allocation of funds and the learning process are subject to moral hazard. The optimal contract is a time-varying share contract which provides intertemporal risk-sharing between venture capitalist and entrepreneur. The share of the entrepreneur reflects the value of a real option. The option itself is based on the control of the funds. The dynamic agency costs may be high and lead to an inefficiently early end to the project. A positive liquidation explains the adoption of strip financing or convertible securities. Finally, relationship financing, including monitoring and the occasional replacement of management improves the efficiency of the financial contracting.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1738.

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Date of creation: Nov 1997
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Handle: RePEc:cpr:ceprdp:1738

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Related research
Keywords: dynamic financial constraints; optimal stopping; relationship finance; Security Design; share contracts; venture financing;

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Find related papers by JEL classification:
D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Investment, or Financing
G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy

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  1. Chan, Yuk-Shee & Siegel, Daniel R & Thakor, Anjan V, 1990. "Learning, Corporate Control and Performance Requirements in Venture Capital Contracts," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 31(2), pages 365-81, May. [Downloadable!] (restricted)
  2. Cornelli, Francesca & Yosha, Oved, 1997. "Stage Financing and the Role of Convertible Debt," CEPR Discussion Papers 1735, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  3. Hart, Oliver & Moore, John, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 841-79, November. [Downloadable!] (restricted)
    Other versions:
  4. Amit, Raphael & Brander, James & Zott, Christoph, 1998. "Why do venture capital firms exist? theory and canadian evidence," Journal of Business Venturing, Elsevier, vol. 13(6), pages 441-466, November. [Downloadable!] (restricted)
  5. Lawrence H. Summers, 1989. "Tax Policy and the Economy, Volume 3," NBER Books, National Bureau of Economic Research, Inc, number summ89-1.
    Other versions:
  6. Berglof, Erik, 1994. "A Control Theory of Venture Capital Finance," Journal of Law, Economics and Organization, Oxford University Press, vol. 10(2), pages 247-67, October.
  7. Admati, Anat R & Pfleiderer, Paul, 1994. " Robust Financial Contracting and the Role of Venture Capitalists," Journal of Finance, American Finance Association, vol. 49(2), pages 371-402, June. [Downloadable!] (restricted)
  8. James M. Poterba, 1989. "Venture Capital and Capital Gains Taxation," NBER Working Papers 2832, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Sahlman, William A., 1990. "The structure and governance of venture-capital organizations," Journal of Financial Economics, Elsevier, vol. 27(2), pages 473-521, October. [Downloadable!] (restricted)
  10. Sagari, Silvia & Guidotti, Gabriela, 1991. "Venture capital operations and their potential role in LDC markets," Policy Research Working Paper Series 540, The World Bank. [Downloadable!]
  11. Lerner, Joshua, 1994. "Venture capitalists and the decision to go public," Journal of Financial Economics, Elsevier, vol. 35(3), pages 293-316, June. [Downloadable!] (restricted)
  12. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October. [Downloadable!] (restricted)
  13. Lerner, Josh, 1995. " Venture Capitalists and the Oversight of Private Firms," Journal of Finance, American Finance Association, vol. 50(1), pages 301-18, March. [Downloadable!] (restricted)
  14. Gompers, Paul A, 1995. " Optimal Investment, Monitoring, and the Staging of Venture Capital," Journal of Finance, American Finance Association, vol. 50(5), pages 1461-89, December. [Downloadable!] (restricted)
  15. Gompers, Paul & Lerner, Josh, 1996. "The Use of Covenants: An Empirical Analysis of Venture Partnership Agreements," Journal of Law & Economics, University of Chicago Press, vol. 39(2), pages 463-98, October.
  16. Cornelli, F. & Yosha, O., 1997. "Stage Financing and the Role of Convertible Debt," Papers 23-97, Tel Aviv.
  17. Gorman, Michael & Sahlman, William A., 1989. "What do venture capitalists do?," Journal of Business Venturing, Elsevier, vol. 4(4), pages 231-248, July. [Downloadable!] (restricted)
  18. Thomas Hellmann, 1998. "The Allocation of Control Rights in Venture Capital Contracts," RAND Journal of Economics, The RAND Corporation, vol. 29(1), pages 57-76, Spring. [Downloadable!] (restricted)
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