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Entrepreneurial Financing and Costly Due Diligence

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  • Chris Yung

Abstract

In the traditional solution to the adverse selection problem, entrepreneurs indirectly signal quality via security choice, typically debt. This paper models an alternative solution. The costly due diligence of venture capitalists directly reveals the quality of projects, thereby reducing information asymmetry. It is shown that this mechanism necessitates profit-sharing, a contractual feature usually associated in the literature with managerial agency costs rather than adverse selection. Copyright (c) 2009, The Eastern Finance Association.

Suggested Citation

  • Chris Yung, 2009. "Entrepreneurial Financing and Costly Due Diligence," The Financial Review, Eastern Finance Association, vol. 44(1), pages 137-149, February.
  • Handle: RePEc:bla:finrev:v:44:y:2009:i:1:p:137-149
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    File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1540-6288.2008.00213.x
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    Cited by:

    1. Cumming, Douglas & Li, Dan, 2013. "Public policy, entrepreneurship, and venture capital in the United States," Journal of Corporate Finance, Elsevier, vol. 23(C), pages 345-367.
    2. Cumming, Douglas J. & Grilli, Luca & Murtinu, Samuele, 2017. "Governmental and independent venture capital investments in Europe: A firm-level performance analysis," Journal of Corporate Finance, Elsevier, vol. 42(C), pages 439-459.
    3. Douglas Cumming, 2010. "Public policy and the creation of active venture capital markets," Venture Capital, Taylor & Francis Journals, vol. 13(1), pages 75-94, April.
    4. Cole, Rebel & Cumming, Douglas & Li, Dan, 2016. "Do banks or VCs spur small firm growth?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 41(C), pages 60-72.
    5. Douglas Cumming & Sofia Johan, 2016. "Venture’s economic impact in Australia," The Journal of Technology Transfer, Springer, vol. 41(1), pages 25-59, February.
    6. Douglas Cumming & Uwe Walz & Jochen Christian Werth, 2016. "Entrepreneurial Spawning: Experience, Education, and Exit," The Financial Review, Eastern Finance Association, vol. 51(4), pages 507-525, November.

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