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The value of benchmarking

  • HEGE, Ulrich
  • BERGEMANN, Dirk

    (Department of Economics, Yale University)

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.

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Paper provided by HEC Paris in its series Les Cahiers de Recherche with number 752.

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Length: 30 pages
Date of creation: 01 Apr 2002
Date of revision:
Handle: RePEc:ebg:heccah:0752
Contact details of provider: Postal: HEC Paris, 78351 Jouy-en-Josas cedex, France
Web page: http://www.hec.fr/

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  1. Klaus Schmidt, 1999. "Convertible Securities and Venture Capital Finance," CESifo Working Paper Series 217, CESifo Group Munich.
  2. 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.
  3. Bergemann, D. & Hege, U., 2001. "The Financing of Innovation : Learning and Stopping," Discussion Paper 2001-16, Tilburg University, Center for Economic Research.
  4. Cochrane, John, 2000. "The Risk and Return of Venture Capital," University of California at Los Angeles, Anderson Graduate School of Management qt7qm9h594, Anderson Graduate School of Management, UCLA.
  5. Stefan Ambec & Michel Poitevin, 2001. "Organizational Design of R&D activities," CSEF Working Papers 60, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  6. Neher, Darwin V, 1999. "Staged Financing: An Agency Perspective," Review of Economic Studies, Wiley Blackwell, vol. 66(2), pages 255-74, April.
  7. Qian, Yingyi & Xu, Chenggang, 1998. "Innovation and Bureaucracy under Soft and Hard Budget Constraints," Review of Economic Studies, Wiley Blackwell, vol. 65(1), pages 151-64, January.
  8. Steven N. Kaplan & Per Stromberg, 2003. "Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts," Review of Economic Studies, Wiley Blackwell, vol. 70(2), pages 281-315, 04.
  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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