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The value of benchmarking

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  • HEGE, Ulrich
  • BERGEMANN, Dirk

    (Department of Economics, Yale University)

Abstract

We consider the provision of venture capital in a dynamic model with multiple research stages, where time and investment needed to meet each benchmark are unknown. The allocation of funds is subject moral hazard. The optimal contract provides for incentive payments linked to attaining the next benchmark, which must be increasing in the funding horizon of each stage. Benchmarking reduces agency costs, directly by shortening the agent's guaranteed funding horizon, and indirectly via an implicit incentive effect of information rents in future financing rounds. The ex ante need to provide incentives and the venture capitalist's desire to cut information rents ex post create a hold-up conflict, which can be overcome by providing all funds in every stage in a single up-front payment. Empirical patterns of the evolution of financing rounds and research intensity over the lifetime of a project are explained as optimal choices: the optimal capital allocated and the funding horizon are increasing from one stage to the next. This emphasizes the notion that early stages are the riskiest in an innovative venture.

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Bibliographic Info

Paper provided by HEC Paris in its series Les Cahiers de Recherche with number 752.

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Length: 30 pages
Date of creation: 01 Apr 2002
Date of revision:
Handle: RePEc:ebg:heccah:0752

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Postal: HEC Paris, 78351 Jouy-en-Josas cedex, France
Web page: http://www.hec.fr/
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Related research

Keywords: venture financing; optimal stopping; benchmarking; stage financing; abandonment option;

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References

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  1. Klaus Schmidt, 1999. "Convertible Securities and Venture Capital Finance," CESifo Working Paper Series 217, CESifo Group Munich.
  2. Cochrane, John, 2000. "The Risk and Return of Venture Capital," University of California at Los Angeles, Anderson Graduate School of Management, Anderson Graduate School of Management, UCLA qt7qm9h594, Anderson Graduate School of Management, UCLA.
  3. Bergemann, Dirk & Hege, Ulrich, 1997. "Venture Capital Financing, Moral Hazard and Learning," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1738, C.E.P.R. Discussion Papers.
  4. Ambec, S. & Poitevin, M., 2001. "Organizational Design of R&D Activities," Cahiers de recherche, Centre interuniversitaire de recherche en économie quantitative, CIREQ 2001-12, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  5. Elitzur, Ramy & Gavious, Arieh, 2003. "A multi-period game theoretic model of venture capitalists and entrepreneurs," European Journal of Operational Research, Elsevier, Elsevier, vol. 144(2), pages 440-453, January.
  6. Dirk Bergemann & Ulrich Hege, 2001. "The Financing of Innovation: Learning and Stopping," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 1292, Cowles Foundation for Research in Economics, Yale University.
  7. Qian, Yingyi & Xu, Chenggang, 1998. "Innovation and Bureaucracy under Soft and Hard Budget Constraints," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 65(1), pages 151-64, January.
  8. Steven N. Kaplan & Per Strömberg, 2000. "Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts," CRSP working papers, Center for Research in Security Prices, Graduate School of Business, University of Chicago 513, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  9. Neher, Darwin V, 1999. "Staged Financing: An Agency Perspective," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 66(2), pages 255-74, April.
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Cited by:
  1. Niinimäki, Juha-Pekka & Takalo, Tuomas & Kultti, Klaus, 2006. "The role of comparing in financial markets with hidden information," Research Discussion Papers, Bank of Finland 1/2006, Bank of Finland.
  2. Juha-Pekka Niinimäki & Tuomas Takalo, 2007. "Benchmarking and Comparing Entrepreneurs with Incomplete Information," Finnish Economic Papers, Finnish Economic Association, Finnish Economic Association, vol. 20(2), pages 91-107, Autumn.
  3. Pierre Giot & Armin Schwienbacher, 2003. "IPOs, Trade Sales and Liquidations: Modelling Venture Capital Exits Using Survival Analysis," Finance, EconWPA 0312006, EconWPA.
  4. Hege, Ulrich & Palomino, Frederic & Schwienbacher, Armin, 2009. "Venture capital performance: the disparity between Europe and the United States," MPRA Paper 39551, University Library of Munich, Germany.

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