The Optimality of Multi-stage Venture Capital Financing: An Option-Theoretic Approach
For venture capital firms, facing undiversifiable risks, multi-staged financing is an optimal contract which offers significant risk reduction at a cost of only slightly lower potential return. The optimality does not depend on the presence of moral hazard and agency problems. Our theoretical model of multi-stage financing, largely based on Asian option pricing theory, allows us to compute the risk reduction ratio due to multi-staging. The return on a staged financing plan is equivalent to an exchange of a straight equity stake for that acquired through stochastic averaging over time. We compare standard deviation ratios for staged vs. up-front financings as well as across asset classes. We find that risk mitigation due to multi-staging is significant in and of itself and enough to markedly improve venture capitalâ€™s risk-reward ratios relative to alternatives.
Volume (Year): 9 (2004)
Issue (Month): 3 (Fall)
|Contact details of provider:|| Postal: 24255 Pacific Coast Hwy, Malibu CA|
Web page: http://bschool.pepperdine.edu/jef
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Kemna, A. G. Z. & Vorst, A. C. F., 1990. "A pricing method for options based on average asset values," Journal of Banking & Finance, Elsevier, vol. 14(1), pages 113-129, March.
- Wang, Susheng & Zhou, Hailan, 2004. "Staged financing in venture capital: moral hazard and risks," Journal of Corporate Finance, Elsevier, vol. 10(1), pages 131-155, January.
- Turnbull, Stuart M. & Wakeman, Lee Macdonald, 1991. "A Quick Algorithm for Pricing European Average Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 26(03), pages 377-389, September.
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
- Geske, Robert, 1979. "The valuation of compound options," Journal of Financial Economics, Elsevier, vol. 7(1), pages 63-81, March.
When requesting a correction, please mention this item's handle: RePEc:pep:journl:v:9:y:2004:i:3:p:1-14. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Craig Everett)
If references are entirely missing, you can add them using this form.