Venture Capital, Agency Costs, and the False Dichotomy of the Corporation
Robert P. Bartlett III
University of California, Berkeley - School of Law; University of California, Berkeley - Berkeley Center for Law, Business and the Economy
UCLA Law Review, Vol. 54, 2006
UGA Legal Studies Research Paper No. 06-006
An implicit dichotomy of the corporation exists in legal scholarship. On one side of the dichotomy rests the publicly-held corporation suffering from a significant conflict of interest between its managers and dispersed shareholders; on the other side, the closely-held corporation plagued by intershareholder conflict.
This Article argues that understanding the agency problems that can exist within a firm demands a rejection of this traditional dichotomy and the theories of the firm built upon it. Using venture capital (VC) finance, this Article demonstrates how this dichotomy obscures how all firms - public and private - often face the same agency problems. Start-up companies receiving VC investment are uniquely situated to examine this dichotomy, as they represent closely-held firms structured to transition quickly to public equity markets. Additionally, by separating investment from company management, VC investment creates many of the investor-manager conflicts inherent in public companies.
By analyzing VC investment contracts, this Article reveals that start-up companies are indeed plagued by both vertical agency problems between investors and managers and horizontal agency problems among VC investors themselves. Significantly, academic scholarship has ignored the potential for interinvestor conflicts, using instead an analytical framework associated with public corporations that focuses exclusively on investor-manager agency problems. In so doing, VC scholarship provides a clear example of how the dichotomy of the corporation forces scholars to wear blinders in analyzing the agency problems in firms. To understand the full scope of these problems - and their implications for corporate investors - a new model of the firm is required that applies to all firms, public and private. This Article outlines this dynamic agency cost model and articulates its implications for corporate investors, corporate scholars, and corporate law in general.
Number of Pages in PDF File: 80
Keywords: Venture Capital, Agency Costs, Private Equity, Corporate Finance, Antidilution, Governance, Theory of the Firm, Corporate Law
JEL Classification: G32, G34, K22
Date posted: March 29, 2006 ; Last revised: December 9, 2007