Venture Capitalists as Principals: Contracting, Screening, and Monitoring

14 Pages Posted: 31 Mar 2001 Last revised: 11 Feb 2010

See all articles by Steven N. Kaplan

Steven N. Kaplan

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Per Strömberg

Swedish House of Finance

Date Written: April 2001

Abstract

Theoretical work on the principal-agent problem in financial contracting focuses on the conflicts of interest between an agent / entrepreneur with a venture that needs financing, and a principal / investor providing funds for the venture. Theory has identified three primary ways that the investor / principal can mitigate these conflicts - structuring financial contracts, pre-investment screening, and post-investment monitoring and advising. In this paper, we describe recent empirical work and its relation to theory for one prominent class of principals venture capitalists (VCs). The empirical studies indicate that VCs attempt to mitigate principal-agent conflicts in the three ways suggested by theory. The evidence also shows that contracting, screening, and monitoring are closely interrelated. In screening, the VCs identify areas where they can add value through monitoring and support. In contracting, the VCs allocate rights in order to facilitate monitoring and minimize the impact of identified risks. Also, the equity allocated to VCs provides incentives to engage in costly support activities that increase upside values, rather than just minimizing potential losses. There is room for future empirical research to study these activities in greater detail for VCs, for other intermediaries such as banks, and within firms.

Suggested Citation

Kaplan, Steven Neil and Stromberg, Per, Venture Capitalists as Principals: Contracting, Screening, and Monitoring (April 2001). NBER Working Paper No. w8202. Available at SSRN: https://ssrn.com/abstract=265297

Steven Neil Kaplan (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-4513 (Phone)
773-702-0458 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Per Stromberg

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

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