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Information and Governance in the Silicon Valley Model

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Author Info
Masahiko Aoki
Abstract

October 1999

This paper argues that the truly unique role of venture capitalists is found in their information-mediating and governance functions, which can be understood only in the context of relationships between the "clustering" of entrepreneurial firms and (a club) of venture capitalists. The entrepreneurial firms in Silicon Valley compete in innovation and thus their activities are fundamentally substitutes. Therefore, their information processing activities need to be encapsulated from each other to excel competitors. A new product system may be then evolutionarily formed by combining modular products ex post that evolve from such decentralized efforts. In order for such evolutionary selection is possible, however, common standards for interfaces among modular products need to be provided to make individual product attributes compatible. Venture capitalists plays an important role in mediating information necessary for endogenously forming and governing competition among entrepreneurs under such framework. The first section assembles stylized facts about venture capital - entrepreneurial firm relationships as a basis for modeling. The second section presents a framework for comparing information systemic aspects of alternative R&D organizations and tries to understand the unique innovation capability of the Silicon Valley model. The third section then proceeds to the analysis of the venture capital governance as an institution for supporting such information system. Repeated tournaments among initially funded firms for refinancing necessary for the completion of projects, and the threat of termination of financial support by the venture capitalist, are seen to provide greater incentives for the entrepreneurs than under traditional arms length financing. The fourth section discusses the incentives of the venture capitalist and other institutional characteristics of the Silicon Valley model.

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Paper provided by Stanford University, Department of Economics in its series Working Papers with number 99028.

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Date of creation: Oct 1999
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Handle: RePEc:wop:stanec:99028

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  1. 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)
  2. Joshua Lerner, 1994. "The Syndication of Venture Capital Investments," Financial Management, Financial Management Association, vol. 23(3), Fall.
  3. Hannan, Michael T & Burton, M Diane & Baron, James N, 1996. "Inertia and Change in the Early Years: Employment Relations in Young, High Technology Firms," Industrial and Corporate Change, Oxford University Press, vol. 5(2), pages 503-36.
  4. 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)
  5. Gompers, Paul & Lerner, Josh, 1996. "The Use of Covenants: An Empirical Analysis of Venture Partnership Agreements," Journal of Law & Economics, University of Chicago Press, vol. 39(2), pages 463-98, October.
  6. Gorman, Michael & Sahlman, William A., 1989. "What do venture capitalists do?," Journal of Business Venturing, Elsevier, vol. 4(4), pages 231-248, July. [Downloadable!] (restricted)
  7. George W. Fenn & Nellie Liang & Stephen Prowse, 1995. "The economics of the private equity market," Staff Studies 168, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  8. Thomas Hellmann, 1998. "The Allocation of Control Rights in Venture Capital Contracts," RAND Journal of Economics, The RAND Corporation, vol. 29(1), pages 57-76, Spring. [Downloadable!] (restricted)
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