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Independent Directors and Board Control in Venture Finance

  • Broughman, Brian
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    The financial contracting literature treats control as an indivisible right held either by a firm’s entrepreneurs or by its investors. In contrast, data from VC-backed firms shows that board control is typically shared, with a third-party independent director holding the tie-breaking board seat (‘ID-arbitration’). In this article I use a bargaining game similar to final offer arbitration to model a firm’s choice of action under ID-arbitration. I show that ID-arbitration can reduce holdup by moderating each party’s ex post threat position. Consequently, ID-arbitration can lead to the efficient outcome in circumstances where alternative governance arrangements – entrepreneur control, investor control, or state-contingent control – are either unavailable or likely to lead to suboptimal results. This project has implications for the literature on financial contracting and the theory of the firm.

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    Paper provided by Berkeley Olin Program in Law & Economics in its series Berkeley Olin Program in Law & Economics, Working Paper Series with number qt9w966114.

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    Date of creation: 01 May 2008
    Date of revision:
    Handle: RePEc:cdl:oplwec:qt9w966114
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    1. Aghion, Philippe & Bolton, Patrick, 1992. "An Incomplete Contracts Approach to Financial Contracting," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 473-94, July.
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    3. Hellmann, Thomas F., 2002. "IPOs, Acquisitions and the Use of Convertible Securities in Venture Capital," Research Papers 1702r, Stanford University, Graduate School of Business.
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    10. Mathias Dewatripont & Philippe Aghion & Patrick Rey, 1994. "Renegotiation design with unverifiable information," ULB Institutional Repository 2013/9591, ULB -- Universite Libre de Bruxelles.
    11. Leslie M. Marx, 1998. "Efficient venture capital financing combining debt and equity," Review of Economic Design, Springer, vol. 3(4), pages 371-387.
    12. Georg Noldeke & Klaus M. Schmidt, 1995. "Option Contracts and Renegotiation: A Solution to the Hold-Up Problem," RAND Journal of Economics, The RAND Corporation, vol. 26(2), pages 163-179, Summer.
    13. Crawford, Vincent P, 1979. "On Compulsory-Arbitration Schemes," Journal of Political Economy, University of Chicago Press, vol. 87(1), pages 131-59, February.
    14. Fried, Jesse M. & Ganor, Mira, 2006. "Agency Costs of Venture Capitalist Control in Startups," Berkeley Olin Program in Law & Economics, Working Paper Series qt5rz3w67b, Berkeley Olin Program in Law & Economics.
    15. Schmidt, Klaus M., 2003. "Convertible Securities and Venture Capital Finance," Munich Reprints in Economics 19769, University of Munich, Department of Economics.
    16. Benjamin E. Hermalin & Michael S. Weisbach, 2001. "Boards of Directors as an Endogenously Determined Institution: A Survey of the Economic Literature," NBER Working Papers 8161, National Bureau of Economic Research, Inc.
    17. Wittman, Donald, 1977. "Candidates with policy preferences: A dynamic model," Journal of Economic Theory, Elsevier, vol. 14(1), pages 180-189, February.
    18. David E. Bloom & Christopher L. Cavanagh, 1986. "An Analysis of the Selection of Arbitrators," NBER Working Papers 1938, National Bureau of Economic Research, Inc.
    19. Berglof, Erik, 1994. "A Control Theory of Venture Capital Finance," Journal of Law, Economics and Organization, Oxford University Press, vol. 10(2), pages 247-67, October.
    20. Steven J. Brams & Samuel Merrill, III, 1983. "Equilibrium Strategies for Final-Offer Arbitration: There is no Median Convergence," Management Science, INFORMS, vol. 29(8), pages 927-941, August.
    21. Black, Bernard S. & Gilson, Ronald J., 1998. "Venture capital and the structure of capital markets: banks versus stock markets," Journal of Financial Economics, Elsevier, vol. 47(3), pages 243-277, March.
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