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Abstract

We model a situation where the entrepreneur has an informational advantage during the early stages of an investment project while the venture capitalist has the informational advantage during the later stages. We examine how this evolution of informational asymmetry affects venture investment and the nature of financing contracts under two different scenarios with regard to the distribution of bargaining power between the venture capitalist and entrepreneur: when the venture capitalist has the bargaining advantage and when the entrepreneur has the bargaining advantage. Our results demonstrate that the distribution of bargaining power has a profound influence both on the terms of contracts and on investments in venture-backed projects. Changes in bargaining power can completely alter the payoff sensitivity of contracts offered to entrepreneurs, and, as witnessed in the recent past, when entrepreneurs hold the bargaining advantage, venture capitalists may acquiesce to excessive investments in early stages of projects and subsequently terminate a larger number of projects.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5806.

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Date of creation: Aug 2006
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Handle: RePEc:cpr:ceprdp:5806

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Related research

Keywords: asymmetric information; bargaining power; financial contracting; investment distortions; venture capital;

Find related papers by JEL classification:

• D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
• G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
• G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

This paper has been announced in the following NEP Reports:

• NEP-ALL-2006-10-28 (All new papers)
• NEP-ENT-2006-10-28 (Entrepreneurship)
• NEP-FIN-2006-10-28 (Finance)

References

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