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Innovation and Venture Capital

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Author Info
Georg Gebhardt (University of Munich)
Abstract

This paper develops a theory why innovation often takes place in new firms that depend overproportionally on external finance usually supplied by specialist intermediaries called venture capitalists. It is argued that innovative projects are characterized by two features: uncertainty that is resolved through a learning by doing process and private benefits for the entrepreneur from running the project. If the effort choice of the entrepreneur is observable to the investor but not contractable the entrepreneur has an incentive not to supply effort to jam the learning process and to prevent the investor from terminating the project. If the investor cannot observe the effort choice his decision must be independent from the actual effort choice and the agency problem can be solved. While banks and internal capital markets suffer from this soft budget constraint problem venture capital funds are immune to it. Because they only have a limited amount of capital new, uninformed investors have to be found to continue the project. This hardens the budget constraint.

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Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1404.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:1404

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  1. Schmidt, Klaus M, 1996. "The Costs and Benefits of Privatization: An Incomplete Contracts Approach," Journal of Law, Economics and Organization, Oxford University Press, vol. 12(1), pages 1-24, April.
  2. Bergemann, Dirk & Hege, Ulrich, 1998. "Venture capital financing, moral hazard, and learning," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 703-735, August. [Downloadable!] (restricted)
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  3. Joshua Lerner, 1994. "The Syndication of Venture Capital Investments," Financial Management, Financial Management Association, vol. 23(3), Fall.
  4. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Blackwell Publishing, vol. 51(3), pages 393-414, July. [Downloadable!] (restricted)
  5. Dewatripont, M & Maskin, E, 1995. "Credit and Efficiency in Centralized and Decentralized Economies," Review of Economic Studies, Blackwell Publishing, vol. 62(4), pages 541-55, October. [Downloadable!] (restricted)
  6. 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)
  7. Rajan, Raghuram G & Zingales, Luigi, 1998. "Financial Dependence and Growth," American Economic Review, American Economic Association, vol. 88(3), pages 559-86, June. [Downloadable!] (restricted)
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  8. 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)
  9. 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)
  10. Paul A. Gompers & Josh Lerner, 1998. "The Determinants of Corporate Venture Capital Successes: Organizational Structure, Incentives, and Complementarities," NBER Working Papers 6725, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  11. Cremer, Jacques, 1995. "Arm's Length Relationships," The Quarterly Journal of Economics, MIT Press, vol. 110(2), pages 275-95, May. [Downloadable!] (restricted)
  12. Kornai, J, 1979. "Resource-Constrained versus Demand-Constrained Systems," Econometrica, Econometric Society, vol. 47(4), pages 801-19, July. [Downloadable!] (restricted)
  13. Samuel Kortum & Josh Lerner, 1998. "Does Venture Capital Spur Innovation?," NBER Working Papers 6846, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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