Investor Abilities and Financial Contracting: Evidence from Venture Capital
Lund University School of Economics and Management; Research Institute of Industrial Economics (IFN)
Berk A. Sensoy
Ohio State University - Fisher College of Business
January 29, 2011
Fisher College of Business Working Paper No. 2009-03-022
Dice Center Working Paper No. 2009-22
Journal of Financial Intermediation, Forthcoming
Using a large, new database of contractual provisions governing the allocation of cash flow rights in venture capital (VC) financings, we investigate how contract design is related to VC abilities to monitor and provide value-added services to the entrepreneur. We find that more experienced VCs, who have superior abilities and more frequently join the boards of their portfolio companies, obtain weaker downside-protecting contractual cash flow rights than less experienced VCs. Several pieces of evidence suggest that this relation is unlikely to be driven by selection effects. The results suggest that VCs with better governance abilities focus less on obtaining downside protections, which entail risk-sharing costs, and more on other aspects of the contract (such as obtaining board representation) during negotiations with entrepreneurs. The results also imply that previous estimates of the amount entrepreneurs pay for affiliation with high-quality VCs are overstated.
Number of Pages in PDF File: 47
Keywords: Venture capital, Financial Contracting, Entrepreneur, Agency
JEL Classification: G24, G32Accepted Paper Series
Date posted: August 21, 2008 ; Last revised: February 19, 2011
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