Friends Don’t Lie: Monitoring and Communication With Risky Investments

37 Pages Posted: 2 Sep 2020

See all articles by Snehal Banerjee

Snehal Banerjee

University of California, San Diego (UCSD) - Rady School of Management

Martin Szydlowski

University of Minnesota - Twin Cities - Carlson School of Management

Date Written: July 24, 2020

Abstract

Venture capital (VC) investors have been criticized for lax monitoring and for being too “founder-friendly.” We identify an overlooked benefit of such behavior: entrepreneurs lie less to friendly VCs. The entrepreneur is privately informed about project success, enjoys private benefits of control, and recommends a project to the VC. The VC chooses the project and can intervene in the interim. The equilibrium features a “monitoring trap”: possible intervention leads the entrepreneur to lie, which prompts further intervention. However, both are better off if the VC commits to intervene less. We characterize implications for information acquisition, control rights, and staged financing.

Keywords: Venture Capital, Cheap Talk, Delegation, Governance

JEL Classification: G24, G32, G34, D83

Suggested Citation

Banerjee, Snehal and Szydlowski, Martin, Friends Don’t Lie: Monitoring and Communication With Risky Investments (July 24, 2020). Available at SSRN: https://ssrn.com/abstract=3660043 or http://dx.doi.org/10.2139/ssrn.3660043

Snehal Banerjee

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States

Martin Szydlowski (Contact Author)

University of Minnesota - Twin Cities - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States

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