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The value of benchmarking

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  • HEGE, Ulrich
  • BERGEMANN, Dirk

    (Department of Economics, Yale University)

Abstract

We consider the provision of venture capital in a dynamic model with multiple research stages, where time and investment needed to meet each benchmark are unknown. The allocation of funds is subject moral hazard. The optimal contract provides for incentive payments linked to attaining the next benchmark, which must be increasing in the funding horizon of each stage. Benchmarking reduces agency costs, directly by shortening the agent's guaranteed funding horizon, and indirectly via an implicit incentive effect of information rents in future financing rounds. The ex ante need to provide incentives and the venture capitalist's desire to cut information rents ex post create a hold-up conflict, which can be overcome by providing all funds in every stage in a single up-front payment. Empirical patterns of the evolution of financing rounds and research intensity over the lifetime of a project are explained as optimal choices: the optimal capital allocated and the funding horizon are increasing from one stage to the next. This emphasizes the notion that early stages are the riskiest in an innovative venture.

Suggested Citation

  • HEGE, Ulrich & BERGEMANN, Dirk, 2002. "The value of benchmarking," HEC Research Papers Series 752, HEC Paris.
  • Handle: RePEc:ebg:heccah:0752
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    References listed on IDEAS

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    1. Klaus M. Schmidt, 2003. "Convertible Securities and Venture Capital Finance," Journal of Finance, American Finance Association, vol. 58(3), pages 1139-1166, June.
    2. Dirk Bergemann & Ulrigh Hege, 2005. "The Financing of Innovation: Learning and Stopping," RAND Journal of Economics, The RAND Corporation, vol. 36(4), pages 719-752, Winter.
    3. Steven N. Kaplan & Per Strömberg, 2003. "Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts," Review of Economic Studies, Oxford University Press, vol. 70(2), pages 281-315.
    4. Darwin V. Neher, 1999. "Staged Financing: An Agency Perspective," Review of Economic Studies, Oxford University Press, vol. 66(2), pages 255-274.
    5. Bergemann, Dirk & Hege, Ulrich, 1998. "Venture capital financing, moral hazard, and learning," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 703-735, August.
    6. Cochrane, John H., 2005. "The risk and return of venture capital," Journal of Financial Economics, Elsevier, vol. 75(1), pages 3-52, January.
    7. Stefan Ambec & Michel Poitevin, 2000. "Organizational Design of R & D Activities," Econometric Society World Congress 2000 Contributed Papers 0190, Econometric Society.
    8. Yingyi Qian & Chenggang Xu, 1998. "Innovation and Bureaucracy Under Soft and Hard Budget Constraints," Review of Economic Studies, Oxford University Press, vol. 65(1), pages 151-164.
    9. Elitzur, Ramy & Gavious, Arieh, 2003. "A multi-period game theoretic model of venture capitalists and entrepreneurs," European Journal of Operational Research, Elsevier, vol. 144(2), pages 440-453, January.
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    Citations

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    Cited by:

    1. Juha-Pekka Niinimäki & Tuomas Takalo, 2007. "Benchmarking and Comparing Entrepreneurs with Incomplete Information," Finnish Economic Papers, Finnish Economic Association, vol. 20(2), pages 91-107, Autumn.
    2. Giot, Pierre & Schwienbacher, Armin, 2007. "IPOs, trade sales and liquidations: Modelling venture capital exits using survival analysis," Journal of Banking & Finance, Elsevier, vol. 31(3), pages 679-702, March.
    3. Ulrich Hege & Frédéric Palomino & Armin Schwienbacher, 2009. "Venture Capital Performance: The Disparity Between Europe and the United States," Finance, Presses universitaires de Grenoble, vol. 30(1), pages 7-50.
    4. Niinimäki, Juha-Pekka & Takalo, Tuomas & Kultti, Klaus, 2006. "The role of comparing in financial markets with hidden information," Research Discussion Papers 1/2006, Bank of Finland.

    More about this item

    Keywords

    venture financing; optimal stopping; benchmarking; stage financing; abandonment option;

    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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