33 Pages Posted: 3 Mar 2007
Date Written: December 2006
In most venture capital financed firms, neither the venture capitalist nor the entrepreneur has exclusive authority over some of the key corporate decisions. For example: the decision whether the firm should undertake an IPO or be sold to a larger rival usually requires the approval of both the entrepreneur and the venture capitalist. This contradicts a strong prediction in the theoretical literature that joint control is suboptimal, except under some limited circumstances. In this paper, I show that when the conflict of interest between the entrepreneur and the venture capitalist over the exit decision is very severe, assigning control jointly to both the agents, and specifying a harsh penalty (such as liquidation) if they fail to reach an agreement may strictly dominate assigning control exclusively to one of the agents. A key factor is the firm's financial slack -- the difference between its expected cash flows and the required investments and monitoring costs. My results provide empirically testable predictions on the impact of firm characteristics and venture capitalist's characteristics on the contract between the entrepreneur and the venture capitalist, and the consequent impact on the timing and manner of the venture capitalist's exit from the firm.
Keywords: Joint Control, Venture Capital, Exit Route
JEL Classification: G24, G30, G32
Suggested Citation: Suggested Citation