The Price of Diversifiable Risk in Venture Capital and Private Equity

53 Pages Posted: 30 Nov 2002 Last revised: 5 Jun 2013

See all articles by Michael Ewens

Michael Ewens

Columbia Business School; National Bureau of Economic Research (NBER)

Charles M. Jones

Columbia University

Matthew Rhodes-Kropf

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

Date Written: May 23, 2013

Abstract

This paper demonstrates how the principal-agent problem between venture capitalists and their investors (limited partners) causes limited partner returns to depend on diversifiable risk. Our theory shows why the need for investors to motivate VCs alters the negotiations between VCs and entrepreneurs and changes how new firms are priced. The three-way interaction rationalizes the use of high discount rates by VCs and predicts a correlation between total risk and net of fee investor returns. We take our theory to a unique data set and find empirical support for the effect of the principal-agent problem on equilibrium private equity asset prices.

Keywords: Venture Capital, Idiosyncratic Risk, Principal-agent problem, Private Equity

JEL Classification: G24, D82, G31

Suggested Citation

Ewens, Michael and Jones, Charles M. and Rhodes-Kropf, Matthew, The Price of Diversifiable Risk in Venture Capital and Private Equity (May 23, 2013). AFA 2003 Washington, DC Meetings, Available at SSRN: https://ssrn.com/abstract=342841 or http://dx.doi.org/10.2139/ssrn.342841

Michael Ewens

Columbia Business School ( email )

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Charles M. Jones (Contact Author)

Columbia University ( email )

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Matthew Rhodes-Kropf

Harvard Business School - Entrepreneurial Management Unit ( email )

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National Bureau of Economic Research (NBER) ( email )

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