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Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts.” Review of Economic Studies 70 (2003)

by Steven Kaplan, Per Strömberg
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The theory of contracts

by Oliver Hart, Bengt Holmstrom , 1986
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Abstract - Cited by 432 (5 self) - Add to MetaCart
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Syndication networks and the spatial distribution of venture capital investments

by Olav Sorenson, Toby E. Stuart - American Journal of Sociology , 2001
"... Sociological investigations of economic exchange reveal how institutions and social structures shape transaction patterns among economic actors. This article explores how interfirm networks in the U.S. venture capital (VC) market affect spatial patterns of exchange. Evidence suggests that informatio ..."
Abstract - Cited by 235 (11 self) - Add to MetaCart
Sociological investigations of economic exchange reveal how institutions and social structures shape transaction patterns among economic actors. This article explores how interfirm networks in the U.S. venture capital (VC) market affect spatial patterns of exchange. Evidence suggests that information about potential investment opportunities generally circulates within geographic and industry spaces. In turn, the circumscribed flow of information within these spaces contributes to the geographic- and industry-localization of VC investments. Empirical analyses demonstrate that the social networks in the VC community—built up through the industry’s extensive use of syndicated investing—diffuse information across boundaries and therefore expand the spatial radius of exchange. Venture capitalists that build axial positions in the industry’s coinvestment network invest more frequently in spatially distant companies. Thus, variation in actors ’ positioning within the structure of the market appears to differentiate market participants ’ ability to overcome boundaries that otherwise would curtail exchange.
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...) work in corporate finance concerns the optimal design of contracts between VCs and target companies to attenuate the agency problems inherent in providing capital to new ventures (for a review, see =-=Kaplan and Stromberg, 1999-=-). Venture capitalists must contend with the possibility that entrepreneurs might pursue their own interests or reduce effort once they receive cash from their financiers (Jensen, 1986). Several aspec...

What do entrepreneurs pay for venture capital affiliation

by David H. Hsu, Joshua Gans, Rick Green (the, Thomas Hellmann, Steve Kaplan, Augustin L, Especially Scott Stern - Journal of Finance , 2004
"... This study empirically evaluates the certification and value-added roles of reputable venture capitalists (VCs). Using a novel sample of entrepreneurial start-ups with multiple financing offers, I analyze financing offers made by competing VCs at the first professional round of start-up funding, hol ..."
Abstract - Cited by 169 (3 self) - Add to MetaCart
This study empirically evaluates the certification and value-added roles of reputable venture capitalists (VCs). Using a novel sample of entrepreneurial start-ups with multiple financing offers, I analyze financing offers made by competing VCs at the first professional round of start-up funding, holding characteristics of the start-up fixed. Offers made by VCs with a high reputation are three times more likely to be accepted, and high-reputation VCs acquire start-up equity at a 10–14 % discount. The evidence suggests that VCs ’ “extra-financial ” value may be more distinctive than their functionally equivalent financial capital. These extra-financial services can have financial consequences. A CENTRAL ISSUE for early-stage high-tech entrepreneurs is obtaining external resourceswhen the assets of their start-up are intangible and knowledge-based. Particularly for entrepreneurs without an established reputation, convincing external resource providers such as venture capitalists (VCs) to provide finan-cial capital may be challenging. The literature contains two main lines of re-search for overcoming this problem. One research stream has concentrated on designing institutional structures to permit financing early-stage ventures. This contractual- and monitoring-based approach is aimed at solving poten-tial agency problems between investors and entrepreneurs (e.g., Admati and Pfleiderer (1994), Lerner (1995), Hellmann (1998), and Kaplan and Strömberg (2001, 2002, 2003)). A second research stream has suggested that when the quality of a start-up cannot be directly observed, external actors rely on the quality of the start-up’s affiliates as a signal of the start-up’s own quality

How does financing impact investment? The role of debt covenants

by Sudheer Chava, Michael R. Roberts - Journal of Finance , 2008
"... We identify a specific channel (debt covenants) and the corresponding mechanism (transfer of control rights) through which financing frictions impact corporate invest-ment. Using a regression discontinuity design, we show that capital investment de-clines sharply following a financial covenant viola ..."
Abstract - Cited by 157 (13 self) - Add to MetaCart
We identify a specific channel (debt covenants) and the corresponding mechanism (transfer of control rights) through which financing frictions impact corporate invest-ment. Using a regression discontinuity design, we show that capital investment de-clines sharply following a financial covenant violation, when creditors use the threat of accelerating the loan to intervene in management. Further, the reduction in in-vestment is concentrated in situations in which agency and information problems are relatively more severe, highlighting how the state-contingent allocation of control rights can help mitigate investment distortions arising from financing frictions. WHILE PREVIOUS RESEARCH HAS CLEARLY ANSWERED THE QUESTION of whether financ-ing and investment are related, it has been much less clear on how financing and investment are related (Stein (2003)). In other words, the precise mech-anisms behind this relationship are largely unknown. Further, the extent to which these mechanisms mitigate or exacerbate investment distortions arising from underlying financing frictions is largely unknown as well. The goal of this

The Risk and Return of Venture Capital

by John H. Cochrane , 2003
"... of a selection-bias correction for venture capital returns, and who also made many useful comments and suggestions. I gratefully acknowledge the contribution of Shawn Blosser, who assembled the venture capital data. I thank many seminar participants and two anonymous referees for important comments ..."
Abstract - Cited by 156 (0 self) - Add to MetaCart
of a selection-bias correction for venture capital returns, and who also made many useful comments and suggestions. I gratefully acknowledge the contribution of Shawn Blosser, who assembled the venture capital data. I thank many seminar participants and two anonymous referees for important comments and suggestions. I gratefully acknowledge research support from NSF grants administered by the NBER and from CRSP. Data, programs, and an appendix describing data procedures and algebra can be found at

The financing of research and development

by Bronwyn H. Hall, Bronwyn H. Hall - Oxford Review of Economic Policy , 2002
"... Evidence on the “funding gap ” for R&D is surveyed. The focus is on financial market reasons for underinvestment in R&D that persist even in the absence of externality-induced underinvestment. The conclusions are that 1) small and new innovative firms experience high costs of capital that ar ..."
Abstract - Cited by 151 (4 self) - Add to MetaCart
Evidence on the “funding gap ” for R&D is surveyed. The focus is on financial market reasons for underinvestment in R&D that persist even in the absence of externality-induced underinvestment. The conclusions are that 1) small and new innovative firms experience high costs of capital that are only partly mitigated by the presence of venture capital; 2) evidence for high costs of R&D capital for large firms is mixed, although these firms do prefer internal funds for financing these investments; 3) there are limits to venture capital as a solution to the funding gap, especially in countries where public equity markets are not highly developed; and 4) further study of governmental seed capital and subsidy programs using quasi-experimental methods is warranted.

Network ties, reputation, and the financing of new ventures

by Scott Shane, Daniel Cable - Management Science , 2002
"... Explaining how entrepreneurs overcome information asymmetry between themselves and potential investors to obtain financing is an important issue for entrepreneurship research. Our premise is that economic explanations for venture finance, which do not consider how social ties influence this process, ..."
Abstract - Cited by 115 (0 self) - Add to MetaCart
Explaining how entrepreneurs overcome information asymmetry between themselves and potential investors to obtain financing is an important issue for entrepreneurship research. Our premise is that economic explanations for venture finance, which do not consider how social ties influence this process, are undersocialized and incomplete. However, we also argue that organization theoretic arguments, which draw on the concept of social obligation, are oversocialized. Drawing on the organizational theory literature, and in-depth fieldwork with 50 high-technology ventures, we examine the effects of direct and indirect ties between entrepreneurs and 202 seed-stage investors on venture finance decisions. We show that these ties influence the selection of ventures to fund through a process of information transfer. (Entrepreneurship; Venture Finance; Social Capital) Entrepreneurs are often wealth constrained, and need to obtain external financing to pursue their opportunities, making financing central to the process of entrepreneurship (Evans and Leighton 1989, Casson
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...ion of contractual rights, the staging of capital, and risk shifting lead entrepreneurs to self-select in ways that overcome the problems engendered by information asymmetry (Gompers and Lerner 2000, =-=Kaplan and Stromberg 1999-=-). For example, Gompers (1997) has noted that venture capitalists use convertible securities and covenants to delay the entrepreneur’s compensation until the outcome of the venture is revealed. Sahlma...

Testing Contract Theory: A Survey of Some Recent Work,”

by P A Chiappori , B Salanié - in Advances in Economics and Econometrics: Theory and Application, Eighth , 2003
"... ..."
Abstract - Cited by 107 (3 self) - Add to MetaCart
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Dynamic Security Design: Convergence to Continuous Time and Asset Pricing Implications,” Review of Economic Studies

by Bruno Biais, Thomas Mariotti, Guillaume Plantin, Jean-charles Rochet, Patrick Bolton, Gian Luca Clementi, Robert Jarrow, Albert Kyle, Roni Michaely, Yuliy Sannikov, Rene ́ Stulz, Oren Sussman, Ernst-ludwig Von Thadden, Jonathan Thomas, Theo Vermaelen
"... An entrepreneur with limited liability needs to finance an infinite horizon investment project. An agency problem arises because she can divert operating cash-flows before reporting them to the financiers. We first study the optimal contract in discrete time. This contract can be implemented by cash ..."
Abstract - Cited by 72 (5 self) - Add to MetaCart
An entrepreneur with limited liability needs to finance an infinite horizon investment project. An agency problem arises because she can divert operating cash-flows before reporting them to the financiers. We first study the optimal contract in discrete time. This contract can be implemented by cash reserves, debt and equity. The latter is split between the financiers and the entrepreneur, and pays dividends when retained earnings reach a threshold. To provide appropriate incentives to the entrepreneur, the firm is downsized when it runs short of cash. We then study the continuous-time limit of the model. We prove the convergence of the discrete-time value functions and optimal contracts. Our analysis yields rich implications for the dynamics of security prices. Stock prices follow a diffusion reflected at the dividend barrier and absorbed at zero. Their volatility, as well as the leverage ratio of the firm, increase after bad performance. Stock prices and book-to-market ratios are in a non-monotonic relationship. A more severe agency problem entails lower price earning ratios and firm liquidity, and higher default risk.

The Financing of R&D and Innovation

by Bronwyn H. Hall, Josh Lerner , 2009
"... Evidence on the “funding gap “ for investment innovation is surveyed. The focus is on financial market reasons for underinvestment that exist even when externality-induced underinvestment is absent. We conclude that while small and new innovative firms experience high costs of capital that are only ..."
Abstract - Cited by 68 (5 self) - Add to MetaCart
Evidence on the “funding gap “ for investment innovation is surveyed. The focus is on financial market reasons for underinvestment that exist even when externality-induced underinvestment is absent. We conclude that while small and new innovative firms experience high costs of capital that are only partly mitigated by the presence of venture capital, the evidence for high costs of R&D capital for large firms is mixed. Neverthless, large established firms do appear to prefer internal funds for financing such investments and they manage their cash flow to ensure this. Evidence shows that there are limits to venture capital as a solution to the funding gap, especially in countries where public equity markets for VC exit are not highly developed. We conclude by suggesting areas
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