Taking Care: How Concerns About Prior Knowledge Affect the Financing of Novel Projects

Abstract

Agents may propose bad projects because they unwittingly rely on defective prior knowledge. Concern about these honest mistakes encourages principals to examine track records of the agents' use of the same prior knowledge. But, such track records cannot exist for novel projects (or routine projects proposed under novel circumstances). Therefore agents may fail to obtain outside financing. This argument helps explain why highly novel ventures that are initially self-financed can subsequently attract outside financing without any decrease in standard 'incentive' or moral hazard problems. It also provides new insights about the differences in the novelty and other attributes of projects financed by individual 'angel' investors, venture capital partnerships and large public companies.

Note: Previously titled "Taking Care: How Efforts to Control Oblivious Ignorance Affect Investment Decisions"

Keywords: Error control; Governance; Joint action; Organizational structure; Innovation

JEL Classification: G30, G31, L11, L20, M13, M40, M46, O31