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Private Information and Bargaining Power in Venture Capital Financing

  • Koskinen, Yrjo

    ()

    (Boston University School of Management and CEPR)

  • Rebello, Michael J.

    (Tulane University)

  • Wang, Jun

    ()

    (Baruch College)

We examine how the relative bargaining power of privately informed venture capitalists and entrepreneurs - determined either by market conditions or by prior experience - affects both the willingness of venture capitalists to invest and the terms of their financing contracts. Our results demonstrate that shifts in the venture capitalists' bargaining power have a profound influence both on the terms of contracts and on investments in venture-backed projects. As witnessed in the recent past, when the bargaining advantage lies with entrepreneurs, venture capitalists may acquiesce to both investing in negative NPV projects and excessive investments in early stages of projects. Further, they will subsequently terminate poor projects. An improvement in the bargaining position of venture capitalists increases the payoff sensitivity of their financing contracts. It also completely attenuates their incentive to overinvest, limiting the need for excessive project terminations arter the initial round of financing.

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Paper provided by Institute for Financial Research in its series SIFR Research Report Series with number 45.

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Length: 52 pages
Date of creation: 15 Sep 2006
Date of revision: 08 Feb 2011
Publication status: Forthcoming as Koskinen, Yrjo, Michael J. Rebello and Jun Wang, 'Private Information and Bargaining Power in Venture Capital Financing' in Journal of Economics and Management Strategy.
Handle: RePEc:hhs:sifrwp:0045
Note: Please find updated version on http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=105962
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