The Role of Independent Directors in VC-Backed Firms

Abstract:     
This paper seeks to explain the widespread use of independent directors in the governance of VC-backed firms, and in particular their use as "tie-breakers" on the boards of these firms. Allocating a tie-breaking vote to an unbiased "arbiter" commits the entrepreneur and VCs to more reasonable behavior and can reduce the opportunism that would result if either party were to control the board. Consistent with my theory, data from Silicon Valley startups illustrate several mechanisms entrepreneurs and VCs use to select an unbiased independent director. I conclude by considering implications for corporate law and fiduciary obligations in VC-backed firms.

Keywords: Venture capital, independent directors, corporate law, incomplete contracting

JEL Classifications: G24, G32, G34, K12, K22, M13

Working Paper Series