The Use of Covenants: An Empirical Analysis of Venture Partnership Agreements

Posted: 17 Nov 2009

See all articles by Paul A. Gompers

Paul A. Gompers

Harvard Business School - Finance Unit; Harvard University - Entrepreneurial Management Unit; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Josh Lerner

Harvard Business School - Finance Unit; Harvard University - Entrepreneurial Management Unit; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: 1996

Abstract

Two complementary hypotheses are explored that may explain the differences in the use of covenants and restrictions in long-term partnership agreements governing venture capital funds. First, because of the high cost of negotiating and monitoring specific covenants, individuals involved in contracts should consider both potential costs and benefits of relying on particular covenants. Second, due to variations in supply and demand, contracting parties should be aware of potential price raises from venture capitalists and restricted activities that enrich the venture capitalists at the expense of investors--which might influence how monetary and private benefits are allocated in contracts. In order to test these hypotheses, a sample of 140 executed contracts is examined, from a major endowment and two investment managers that select venture capital investments for pension funds and other institutional investors. The contracts were reviewed for the presence of 14 classes of covenant restrictions. The evidence shows that both factors are important determinants of contractual restrictiveness. Supply and demand proxies are consistently significant in univariate and regression analysis. When the covenants are grouped into three families -- related to overall fund management, activities of the general partners, and types of investment -- supply and demand proxies are related to all three families of covenants. Those that address agency/oversight problems, or contracting costs, are related to covenants that restrict the management of the fund types of investment activities. (SFL)

Keywords: Covenants, Monitoring, Agency problems, Venture capital, Contracts & agreements, Interfirm alliances, Supply & demand, Investment policies, Costs

Suggested Citation

Gompers, Paul A. and Lerner, Josh, The Use of Covenants: An Empirical Analysis of Venture Partnership Agreements (1996). Journal of Law and Economics, Vol. 39, Issue 2, p. 463-498 1996. Available at SSRN: https://ssrn.com/abstract=1505908

Paul A. Gompers (Contact Author)

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6297 (Phone)
617-496-8443 (Fax)

Harvard University - Entrepreneurial Management Unit ( email )

Cambridge, MA 02163
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Josh Lerner

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6065 (Phone)
617-496-7357 (Fax)

HOME PAGE: http://www.people.hbs.edu/jlerner/

Harvard University - Entrepreneurial Management Unit

Cambridge, MA 02163
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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