When Do Firms Risk Shift? Evidence from Venture Capital

58 Pages Posted: 29 Nov 2016 Last revised: 1 Oct 2017

See all articles by Matthew Denes

Matthew Denes

Carnegie Mellon University - Tepper School of Business

Date Written: August 25, 2017


This paper studies the agency costs of debt and the role of risk shifting as firms face financial distress. The Small Business Investment Company (SBIC) program is a novel setting to evaluate the importance of these costs. It provides participating venture capital funds with debt financing from the U.S. government at a negligible premium to the 10-year Treasury Note. Economic mechanisms that might prevent risk shifting, such as covenants and reputation concerns, are primarily not present in this program. Using a difference-in-differences setting, I find that managers of distressed funds invest in firms with lower credit scores, sales, employment and patenting activity, and are more likely to use equity investments. Distressed funds reallocate capital to riskier firms in their portfolio, rather than searching for new investments. Equityholders respond positively to riskier investments for distressed funds and debtholder losses increase, consistent with the prediction that risk shifting transfers wealth from bondholders to equityholders.

Keywords: risk shifting, asset substitution, venture capital, innovation

JEL Classification: G24, G32, H25, O31

Suggested Citation

Denes, Matthew, When Do Firms Risk Shift? Evidence from Venture Capital (August 25, 2017). Finance Down Under 2018 Building on the Best from the Cellars of Finance Paper, Available at SSRN: https://ssrn.com/abstract=2875882 or http://dx.doi.org/10.2139/ssrn.2875882

Matthew Denes (Contact Author)

Carnegie Mellon University - Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

HOME PAGE: http://sites.google.com/site/matthewdenes

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
PlumX Metrics