Moral Hazard in VC Finance: More Expensive than You Thought

36 Pages Posted: 1 May 2016 Last revised: 21 Dec 2016

See all articles by Julius Tennert

Julius Tennert

University of Hohenheim

Marie Lambert

University of Liege - HEC Management School

Hans-Peter Burghof

University of Hohenheim

Date Written: December 12, 2016

Abstract

Venture projects are fraught with exogenous market risk and endogenous agency risk. We apply a real options perspective to analyze the investment decision of the venture capitalist (VC) in this set-up. The solutions presented are conflictive: the VC reduces his exposure to exogenous risk by delaying investments to wait for informational updates (delay option), but mitigates endogenous risk by advancing investments to discover entrepreneur’s effort. So far, papers focus on the optimal timing of investments considering independence of exogenous and endogenous risk. We show that interdependence of exogenous risk and endogenous risk exists. We find that endogenous risk prompts the VC to accelerate the discovery process when exogenous risk is high, and to abandon the delay option when it is most valuable.

Keywords: Venture Finance, Real Option, Agency Cost, Moral Hazard

JEL Classification: G11, G12, G24, D53

Suggested Citation

Tennert, Julius and Lambert, Marie and Burghof, Hans-Peter, Moral Hazard in VC Finance: More Expensive than You Thought (December 12, 2016). Available at SSRN: https://ssrn.com/abstract=2773050 or http://dx.doi.org/10.2139/ssrn.2773050

Julius Tennert (Contact Author)

University of Hohenheim ( email )

Fruwirthstr. 48
Stuttgart, 70599
Germany

Marie Lambert

University of Liege - HEC Management School ( email )

HEC-Liège
rue Louvrex 14
LIEGE, Liege 4000
Belgium

Hans-Peter Burghof

University of Hohenheim ( email )

Schloss Hohenheim
510F
Stuttgart, 70599
Germany
+49 711 459 22900 (Phone)
+49 711 459 23448 (Fax)

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