Independent Directors and Shared Board Control in Venture Finance

Abstract

In most VC-backed firms neither the entrepreneurs nor the VC investors control the board. Instead control is typically shared with a mutually appointed independent director holding the tie-breaking seat. Contract theory, which treats control as an indivisible right held by one party, does not have a good explanation for this practice. Using a bargaining game similar to final offer arbitration, I show that an independent director as tie-breaker can reduce holdup by moderating each party’s ex post threat position, potentially expanding the range of firms which receive external financing. This project contributes to the literature on incomplete contracting and holdup, and improves our understanding of governance arrangements in startup firms.

Keywords: Venture capital, control rights, incomplete contracting, corporate governance, board of directors

JEL Classification: G24, G32, G34. K12, K22, M13