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The Application of Principal-Agent Methods to Investor-Investee Relations in the UK Venture Capital Industry

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  • Gavin C Reid

Abstract

Principal-agent analysis is applied to contemporary evidence on venture capital investment. The investor (as principal) and investee (as agent) are analysed in terms of risk management, information handling and the trading of risk and information. Investors and investees were paired in 'dyads', with each party being subject to separate face-to-face interviews. The paper develops the appropriate principal-agent models for dealing with incentives for entrepreneurial effort and issues of information and monitoring. The way in which investees and investors seek contract optimality is then examined, using qualitative data. It is shown that the evidence provides striking confirmation of the applicability of the principal-agent model to the venture capital financing of mature small firms. The most crucial feature of contract optimality was perceived to be the propoer choice of capital structure. This established ownership entitlement, created incentives for effort, and apportioned risk eficiently. Many investor-investee relations were perceived to be at or close to contract optimality. These optima were specific to time and place situations and strongly reflected individual house-styles of investors. Investor reputations were strongly attached to house styles.

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Bibliographic Info

Paper provided by Centre for Research into Industry, Enterprise, Finance and the Firm in its series CRIEFF Discussion Papers with number 9810.

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Date of creation: Oct 1998
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Handle: RePEc:san:crieff:9810

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Keywords: principal-agent model; entrepreneurship; mature small firms; venture capital; risk-bearing; information handling; contract optimality;

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References

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  1. Gavin C Reid & Julia A Smith, 1996. "What Makes a New Business Start-Up Successful?," CRIEFF Discussion Papers, Centre for Research into Industry, Enterprise, Finance and the Firm 9618, Centre for Research into Industry, Enterprise, Finance and the Firm.
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Cited by:
  1. Gavin C. Reid & Julia A. Smith, 2003. "Venture Capital and Risk in High-Technology Enterprises," International Journal of Business and Economics, College of Business, and College of Finance, Feng Chia University, Taichung, Taiwan, College of Business, and College of Finance, Feng Chia University, Taichung, Taiwan, vol. 2(3), pages 227-244, December.
  2. José Martí Pellón & Marina Balboa, 2003. "Characterisation Of The Reputation Of Private Equity Managers: Evidence In Spain," Working Papers. Serie EC, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie) 2003-16, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
  3. Hanna Silvola, 2008. "Design of MACS in growth and revival stages of the organizational life-cycle," Qualitative Research in Accounting & Management, Emerald Group Publishing, Emerald Group Publishing, vol. 5(1), pages 27-47, April.
  4. F. Fakhfakh & F. Fitzroy, 2003. "Basic Wages and Firm Characteristics : Rent-sharing in French Manufacturing," Working Papers ERMES, ERMES, University Paris 2 0311, ERMES, University Paris 2.
  5. Gavin C. Reid, 2002. "Investor Conduct Towards New High Technology Firms: UK Evidence on How Risk is Managed," CRIEFF Discussion Papers, Centre for Research into Industry, Enterprise, Finance and the Firm 0206, Centre for Research into Industry, Enterprise, Finance and the Firm.
  6. Gavin C. Reid & Julia A. Smith, 2001. "How do Venture Capitalists Handle Risk in High-Technology Ventures? - some preliminary results," CRIEFF Discussion Papers, Centre for Research into Industry, Enterprise, Finance and the Firm 0107, Centre for Research into Industry, Enterprise, Finance and the Firm.
  7. Gavin C Reid & Julia A Smith, 1999. "Accounting for Risk: developing a new research agenda for risk appraisal in high-technology ventures," CRIEFF Discussion Papers, Centre for Research into Industry, Enterprise, Finance and the Firm 9915, Centre for Research into Industry, Enterprise, Finance and the Firm.
  8. Wolf, Björn, 2006. "Empirische Untersuchung zu den Einflussfaktoren der Finanzierungsprobleme junger Unternehmen in Deutschland und deren Auswirkungen auf die Wirtschaftspolitik," Working Papers "Firms and Region" U1/2006, Fraunhofer Institute for Systems and Innovation Research (ISI).
  9. Gavin C. Reid & Julia A. Smith, 2002. "Investor and Investee Conduct in the Risk Appraisal of High Technology New Ventures in the UK," CRIEFF Discussion Papers, Centre for Research into Industry, Enterprise, Finance and the Firm 0205, Centre for Research into Industry, Enterprise, Finance and the Firm.
  10. Edmund H. Mantell, 2008. "A Probabilistic Theory Of Entrepreneurial Financing," Annals of Economics and Finance, Society for AEF, vol. 9(1), pages 177-197, May.
  11. Jesper Lindgaard Christensen, 2008. "The IPR System, Venture Capital and Capital Markets – Contributions and Distortions of Small Firm Innovation?," DRUID Working Papers 08-03, DRUID, Copenhagen Business School, Department of Industrial Economics and Strategy/Aalborg University, Department of Business Studies.

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