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Financing Entrepreneurs: Optimal Contracts and the Role of Intermediaries

  • Roberta Dessí

I study an economy in which entrepreneurs seek financing for long-term projects from intermediaries, who specialise in monitoring, and uninformed investors. Monitoring enables an intermediary to affect investment decisions, and to learn the firms probability of success. Optimal financial contracts are designed to induce both ex ante (choice of investment project) and ex post (decision to continue or liquidate) efficiency. The results can account for some common characteristics of venture capital financing: (a) the fact that venture capitalists are given substantial control rights, (b) the use of convertible securities, (c) the fact the continuation finance is often raised through an IPO, while venture capitalists typically do not exit at this point.

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File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmg_pdfs/dp328.pdf
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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp328.

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Date of creation: Jun 1999
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Handle: RePEc:fmg:fmgdps:dp328
Contact details of provider: Web page: http://www.lse.ac.uk/fmg/

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  1. Brav, Alon & Gompers, Paul A, 1997. " Myth or Reality? The Long-Run Underperformance of Initial Public Offerings: Evidence from Venture and Nonventure Capital-Backed Companies," Journal of Finance, American Finance Association, vol. 52(5), pages 1791-1821, December.
  2. 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.
  3. 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.
  4. Thomas Hellmann, 1998. "The Allocation of Control Rights in Venture Capital Contracts," RAND Journal of Economics, The RAND Corporation, vol. 29(1), pages 57-76, Spring.
  5. Samuel Kortum & Josh Lerner, 1998. "Does Venture Capital Spur Innovation?," NBER Working Papers 6846, National Bureau of Economic Research, Inc.
  6. Bengt Holmstrom & Jean Tirole, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," Working papers 95-1, Massachusetts Institute of Technology (MIT), Department of Economics.
  7. Lerner, Joshua, 1994. "Venture capitalists and the decision to go public," Journal of Financial Economics, Elsevier, vol. 35(3), pages 293-316, June.
  8. Sahlman, William A., 1990. "The structure and governance of venture-capital organizations," Journal of Financial Economics, Elsevier, vol. 27(2), pages 473-521, October.
  9. Gompers, Paul & Lerner, Josh, 1996. "The Use of Covenants: An Empirical Analysis of Venture Partnership Agreements," Journal of Law and Economics, University of Chicago Press, vol. 39(2), pages 463-98, October.
  10. Cornelli, F. & Yosha, O., 1997. "Stage Financing and the Role of Convertible Debt," Papers 23-97, Tel Aviv.
  11. Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-400, September.
  12. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
  13. Megginson, William L & Weiss, Kathleen A, 1991. " Venture Capitalist Certification in Initial Public Offerings," Journal of Finance, American Finance Association, vol. 46(3), pages 879-903, July.
  14. Gompers, Paul A., 1996. "Grandstanding in the venture capital industry," Journal of Financial Economics, Elsevier, vol. 42(1), pages 133-156, September.
  15. Gorman, Michael & Sahlman, William A., 1989. "What do venture capitalists do?," Journal of Business Venturing, Elsevier, vol. 4(4), pages 231-248, July.
  16. Cornelli, Francesca & Yosha, Oved, 1997. "Stage Financing and the Role of Convertible Debt," CEPR Discussion Papers 1735, C.E.P.R. Discussion Papers.
  17. Ernst-Ludwig von Thadden, 1995. "Long-Term Contracts, Short-Term Investment and Monitoring," Review of Economic Studies, Oxford University Press, vol. 62(4), pages 557-575.
  18. Lerner, Josh, 1995. " Venture Capitalists and the Oversight of Private Firms," Journal of Finance, American Finance Association, vol. 50(1), pages 301-18, March.
  19. Gompers, Paul A, 1995. " Optimal Investment, Monitoring, and the Staging of Venture Capital," Journal of Finance, American Finance Association, vol. 50(5), pages 1461-89, December.
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