Financing Experimentation

61 Pages Posted: 9 Jun 2021 Last revised: 14 Oct 2021

See all articles by Tong Liu

Tong Liu

University of Pennsylvania - Finance Department

Date Written: May 15, 2021


Leveraging the detailed project-level data on biotech startups and their IPO records, this paper studies how adverse selection in capital markets affects financing decisions of entrepreneurs and firm 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 24% loss of ex-ante firm value, which is due to the 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 startups 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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