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Venture Capital Financing, Moral Hazard and Learning

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  • Bergemann, Dirk
  • Hege, Ulrich

Abstract

We consider the provision of venture capital in a dynamic agency model. The value of the venture project is initially uncertain and more information arrives by developing the project. The allocation of funds and the learning process are subject to moral hazard. The optimal contract is a time-varying share contract which provides intertemporal risk-sharing between venture capitalist and entrepreneur. The share of the entrepreneur reflects the value of a real option. The option itself is based on the control of the funds. The dynamic agency costs may be high and lead to an inefficiently early end to the project. A positive liquidation explains the adoption of strip financing or convertible securities. Finally, relationship financing, including monitoring and the occasional replacement of management improves the efficiency of the financial contracting.

Suggested Citation

  • Bergemann, Dirk & Hege, Ulrich, 1997. "Venture Capital Financing, Moral Hazard and Learning," CEPR Discussion Papers 1738, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:1738
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    Keywords

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    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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