Entrepreneurial Financing and Costly Due Diligence

13 Pages Posted: 20 Jan 2009

See all articles by Chris Yung

Chris Yung

University of Virginia - McIntire School of Commerce

Abstract

In the traditional solution to the adverse selection problem, entrepreneurs indirectly signal quality via security choice, typically debt. This paper models an alternative solution. The costly due diligence of venture capitalists directly reveals the quality of projects, thereby reducing information asymmetry. It is shown that this mechanism necessitates profit-sharing, a contractual feature usually associated in the literature with managerial agency costs rather than adverse selection.

Suggested Citation

Yung, Chris, Entrepreneurial Financing and Costly Due Diligence. Financial Review, Vol. 44, Issue 1, pp. 137-149, February 2009. Available at SSRN: https://ssrn.com/abstract=1330203 or http://dx.doi.org/10.1111/j.1540-6288.2008.00213.x

Chris Yung (Contact Author)

University of Virginia - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States
434-242-0836 (Phone)

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