Financing Experimentation

61 Pages Posted: 9 Jun 2021 Last revised: 3 Nov 2021

See all articles by Tong Liu

Tong Liu

University of Pennsylvania - Finance Department

Date Written: May 15, 2021


Leveraging detailed project-level data on biotech startups and their IPO records, this paper studies how adverse selection in capital markets affects entrepreneurs' financing decisions as well as startup values. By structurally estimating a dynamic model that features strategic experimentation and volatile market valuation, I find that adverse selection is prevalent between early-stage startups and investors. The baseline estimates suggest that information frictions cause about a 24% loss of ex ante firm value, which is due to distortion of market beliefs and higher financing costs in private markets. On average, asymmetric information induces startups to stay private for approximately 5 years longer, consistent with the sharp decline of IPOs observed in the last two decades. The effects of information frictions, however, are dampened among VC-backed startups, startups with more effective patent fences, and those facing more stringent requirements on public disclosure of clinical trial results.

Keywords: Entrepreneurship, experimentation, IPO, adverse selection, healthcare

JEL Classification: G24, G32, L26, E22, O31, D82, L65, C51, C73

Suggested Citation

Liu, Tong, Financing Experimentation (May 15, 2021). Available at SSRN: or

Tong Liu (Contact Author)

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States


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