Secret Scouting

43 Pages Posted: 17 Sep 2019

See all articles by Xuelin Li

Xuelin Li

University of South Carolina - Darla Moore School of Business

Fangyuan Yu

University of Minnesota

Date Written: September 1, 2019

Abstract

VCs prefer secrecy when searching for targets. As a result, only the investments in viable startups are disclosed but the failed ones are discarded silently. We extend the standard preemption game to explain the efficiency loss and the individual rationale of doing so. We show that secrecy creates pessimism. Compared to the fully disclosing case, VCs will stop hunting for startups too early in an initially promising industry. This could happen even if no technology failures are observed in realization. However, hiding failures becomes a dominant strategy when the return of the VC industry is right-skewed. VCs use secret scouting to make the competitors believe that the industry is a dead end and reduce the preemption threats.

Keywords: Preemption, Venture Capital, Search, Disclosure

JEL Classification: G14, G24, G32, D62, D83

Suggested Citation

Li, Xuelin and Yu, Fangyuan, Secret Scouting (September 1, 2019). Available at SSRN: https://ssrn.com/abstract=3449798 or http://dx.doi.org/10.2139/ssrn.3449798

Xuelin Li (Contact Author)

University of South Carolina - Darla Moore School of Business ( email )

1014 Greene Street
Columbia, SC 29208
United States

Fangyuan Yu

University of Minnesota ( email )

Minneapolis, MN
United States
6122275167 (Phone)
55455 (Fax)

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