36 Pages Posted: 18 Apr 2006
Date Written: April 10, 2006
We analyze the incentive problems that arise from the possibility for idea theft in the venture capital context, where the success of a start-up firm hinges on the unobservable efforts of both an entrepreneur, and a venture capitalist. The risk of idea theft is shown to destroy the entrepreneur's research effort incentives, thereby reducing the likelihood of innovation, and the value of the start-up firm ex ante. When idea theft is potentially verifiable ex post, the threat of litigation can solve the incentive problems for some projects. However, it is insufficient whenever a project's profit potential is sufficiently large, and whenever the ex ante probability that theft will be verifiable ex post is too small. Investment syndication is shown to offer a potential solution for the latter type of projects. The model's novel empirical predictions pertain to the relationship between the project characteristics, the size and the structure of a VC syndicate, and the probability of successful innovation.
Keywords: Venture Capital, Innovation, Idea Theft, Moral Hazard, Syndication
JEL Classification: G24, G32
Suggested Citation: Suggested Citation