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Innovation and Venture Capital

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  • Georg Gebhardt

    (University of Munich)

Abstract

This paper develops a theory why innovation often takes place in new firms that depend overproportionally on external finance usually supplied by specialist intermediaries called venture capitalists. It is argued that innovative projects are characterized by two features: uncertainty that is resolved through a learning by doing process and private benefits for the entrepreneur from running the project. If the effort choice of the entrepreneur is observable to the investor but not contractable the entrepreneur has an incentive not to supply effort to jam the learning process and to prevent the investor from terminating the project. If the investor cannot observe the effort choice his decision must be independent from the actual effort choice and the agency problem can be solved. While banks and internal capital markets suffer from this soft budget constraint problem venture capital funds are immune to it. Because they only have a limited amount of capital new, uninformed investors have to be found to continue the project. This hardens the budget constraint.

Suggested Citation

  • Georg Gebhardt, 2000. "Innovation and Venture Capital," Econometric Society World Congress 2000 Contributed Papers 1404, Econometric Society.
  • Handle: RePEc:ecm:wc2000:1404
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    References listed on IDEAS

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    1. 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.
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    3. M. Dewatripont & E. Maskin, 1995. "Credit and Efficiency in Centralized and Decentralized Economies," Review of Economic Studies, Oxford University Press, vol. 62(4), pages 541-555.
    4. Rajan, Raghuram G & Zingales, Luigi, 1998. "Financial Dependence and Growth," American Economic Review, American Economic Association, vol. 88(3), pages 559-586, June.
    5. Gompers, Paul A, 1995. " Optimal Investment, Monitoring, and the Staging of Venture Capital," Journal of Finance, American Finance Association, vol. 50(5), pages 1461-1489, December.
    6. Paul Gompers & Josh Lerner, 2000. "The Determinants of Corporate Venture Capital Success: Organizational Structure, Incentives, and Complementarities," NBER Chapters,in: Concentrated Corporate Ownership, pages 17-54 National Bureau of Economic Research, Inc.
    7. Kornai, J, 1979. "Resource-Constrained versus Demand-Constrained Systems," Econometrica, Econometric Society, vol. 47(4), pages 801-819, July.
    8. Samuel Kortum & Josh Lerner, 1998. "Does Venture Capital Spur Innovation?," NBER Working Papers 6846, National Bureau of Economic Research, Inc.
    9. Schmidt, Klaus M, 1996. "The Costs and Benefits of Privatization: An Incomplete Contracts Approach," Journal of Law, Economics, and Organization, Oxford University Press, vol. 12(1), pages 1-24, April.
    10. Joshua Lerner, 1994. "The Syndication of Venture Capital Investments," Financial Management, Financial Management Association, vol. 23(3), Fall.
    11. Jacques Crémer, 1995. "Arm's Length Relationships," The Quarterly Journal of Economics, Oxford University Press, vol. 110(2), pages 275-295.
    12. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
    13. Lerner, Josh, 1995. " Venture Capitalists and the Oversight of Private Firms," Journal of Finance, American Finance Association, vol. 50(1), pages 301-318, March.
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