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Self-Selection and Advice in Venture Capital Finance

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  • Christian Keuschnigg

    ()

  • Soren Bo Nielsen

    ()

Abstract

In financing start-up firms, venture capitalists carefully select among alternative projects, design incentive compatible financial contracts and support portfolio companies with value enhancing managerial advice. This paper considers how venture capitalists can induce self-selection among entrepreneurial firms with different qualities and growth potential by designing appropriate contracts and offering managerial support. We study the efficiency of the competitive market equilibrium with respect to the level and quality of entrepreneurship and the level of effort by entrepreneurs and venture capitalists. We also provide comparative static results with respect to basic preference and technology parameters.

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Bibliographic Info

Paper provided by Department of Economics, University of St. Gallen in its series University of St. Gallen Department of Economics working paper series 2006 with number 2006-06.

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Length: 32 pages
Date of creation: Mar 2006
Date of revision:
Handle: RePEc:usg:dp2006:2006-06

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Keywords: Venture capital; entrepreneurship; self-selection; moral hazard;

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References

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  1. Masako Ueda, 2004. "Banks versus Venture Capital: Project Evaluation, Screening, and Expropriation," Journal of Finance, American Finance Association, vol. 59(2), pages 601-621, 04.
  2. Vesa Kanniainen & Christian Keuschnigg, 2000. "The Optimal Portfolio of Start-Up Firms in Venture Capital Finance," CESifo Working Paper Series 381, CESifo Group Munich.
  3. Christian Keuschnigg & Søren Bo Nielsen, 2003. "Taxes and Venture Capital Support," CESifo Working Paper Series 1094, CESifo Group Munich.
  4. Robin Boadway & Michael Keen, 2004. "Financing New Investments under Asymmetric Information: A General Approach," Working Papers 1017, Queen's University, Department of Economics.
  5. Da Rin, Marco & Nicodano, Giovanna & Sembenelli, Alessandro, 2006. "Public policy and the creation of active venture capital markets," Journal of Public Economics, Elsevier, vol. 90(8-9), pages 1699-1723, September.
  6. Klaus Schmidt, 1999. "Convertible Securities and Venture Capital Finance," CESifo Working Paper Series 217, CESifo Group Munich.
  7. Cumming, Douglas J., 2005. "Capital structure in venture finance," Journal of Corporate Finance, Elsevier, vol. 11(3), pages 550-585, June.
  8. Repullo, R. & Suarez, J., 1998. "Venture Capital Finance: a Security Design Approach," Papers 9804, Centro de Estudios Monetarios Y Financieros-.
  9. Keuschnigg, Christian & Nielsen, Soren Bo, 2003. "Taxation and Venture Capital-Backed Entrepreneurship," CEPR Discussion Papers 4097, C.E.P.R. Discussion Papers.
  10. de Meza, David & Webb, David C, 1987. "Too Much Investment: A Problem of Asymmetric Information," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 281-92, May.
  11. Catherine Casamatta, 2003. "Financing and Advising: Optimal Financial Contracts with Venture Capitalists," Journal of Finance, American Finance Association, vol. 58(5), pages 2059-2086, October.
  12. Steven N. Kaplan & Per Stromberg, 2002. "Characteristics, Contracts, and Actions: Evidence from Venture Capitalist Analyses," NBER Working Papers 8764, National Bureau of Economic Research, Inc.
  13. Samuel Kortum & Josh Lerner, 2000. "Assessing the Contribution of Venture Capital to Innovation," RAND Journal of Economics, The RAND Corporation, vol. 31(4), pages 674-692, Winter.
  14. Steven N. Kaplan & Per Stromberg, 2000. "Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts," NBER Working Papers 7660, National Bureau of Economic Research, Inc.
  15. Steven N. Kaplan & Per Stromberg, 2001. "Venture Capitalists As Principals: Contracting, Screening, and Monitoring," NBER Working Papers 8202, National Bureau of Economic Research, Inc.
  16. Masako Ueda, 2000. "Bank versus venture capital," Economics Working Papers 522, Department of Economics and Business, Universitat Pompeu Fabra.
  17. Inderst, Roman & Muller, Holger M., 2004. "The effect of capital market characteristics on the value of start-up firms," Journal of Financial Economics, Elsevier, vol. 72(2), pages 319-356, May.
  18. David de Meza, 2002. "Overlending?," Economic Journal, Royal Economic Society, vol. 112(477), pages F17-F31, February.
  19. Hellmann, Thomas & Puri, Manju, 2000. "The Interaction between Product Market and Financing Strategy: The Role of Venture Capital," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 13(4), pages 959-84.
  20. Robert E. Hall, 2005. "The Amplification of Unemployment Fluctuations through Self-Selection," NBER Working Papers 11186, National Bureau of Economic Research, Inc.
  21. Innes, Robert, 1991. "Investment and government intervention in credit markets when there is asymmetric information," Journal of Public Economics, Elsevier, vol. 46(3), pages 347-381, December.
  22. Bengt Holmstrom, 1982. "Moral Hazard in Teams," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 324-340, Autumn.
  23. Fuest, Clemens & Tillessen, Philipp, 2005. "Why do governments use closed ended subsidies to support entrepreneurial investment?," Economics Letters, Elsevier, vol. 89(1), pages 24-30, October.
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