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Contractual Relations between European VC–Funds and Investors: The Impact of Reputation and Bargaining Power on Contractual Design
Abstract
The paper explores factors that influence the design of financing contracts between venture capital investors and European venture capital funds. 122 Private Placement Memoranda and 46 Partnership Agreements are investigated in respect to the use of covenant restrictions and compensation schemes. The analysis focuses on the impact of two key factors: the reputation of VC-funds and changes in the overall demand for venture capital services. We find that established funds are more severely restricted by contractual covenants. This contradicts the conventional wisdom which assumes that established market participants care more about their reputation, have less incentive to behave opportunistically and therefore need less covenant restrictions. We also find that managers of established funds are more often obliged to invest own capital alongside with investors money. We interpret this as evidence that established funds have actually less reason to care about their reputation as compared to young funds. One reason for this surprising result could be that managers of established VC funds are older and closer to retirement and therefore put less weight on the effects of their actions on future business opportunities. We also explore the effects of venture capital supply on contract design. Gompers and Lerner (1996) show that VC-funds in the US are able to reduce the number of restrictive covenants in years with high supply of venture capital and interpret this as a result of increased bargaining power by VC-funds. We do not find similar evidence for Europe. Instead, we find that VC-funds receive less base compensation and higher performance related compensation in years with strong capital inflows into the VC industry. This may be interpreted as a signal of overconfidence: Strong investor demand seems to coincide with overoptimistic expectations by fund managers which make them willing to accept higher powered incentive schemes.
... Bankman and Cole (2001) study the underlying reasons for venture capital investments in a period where companies were overvalued and suggest that avoiding a loss of reputation on the PEO's side may have been one of them. Finally, Schmidt and Wahrenburg (2003) examine the effects of the reputation and bargaining power of PEOs on the design of partnership agreements. However, none of all these articles analyzes how PEOs establish their reputation in their relationship with investors, and this is the main contribution of this paper. ...
... Thus, by signaling their reputation PEOs contribute to reducing the problems of information asymmetry. In fact, as Schmidt and Wahrenburg (2003) point out, reputation can be seen as a security given by the agent to the principal. We agree with Rosenstein et al. (1990) that reputation can be linked to track record. ...
... As indicated by Smith (1999) and Schertler (2002), PEOs strive to establish a good reputation in order to attract investors to their funds. In fact, reputation determines the ability of managers to raise funds in developed private equity markets (Norton, 1995;Gompers and Lerner, 2001b;Janney and Folta, 2003;Schmidt and Wahrenburg, 2003). This should also be expected in developing countries. ...
... In terms of empirical studies on covenants, the seminal work was undertaken by Gompers and Lerner (1996;1999), who analyze the covenants used to govern VCLPs in the US. Subsequent work (Schmidt and Wahrenburg, 2003;Cumming and Johan, 2005) considers similar evidence in an international context. One type of covenant among VCLPs is the restriction on the fund manager regarding investment decisions. ...
... study such style drifts in a sample of US data, and show drifts are related to fund age (first-time fund managers are less likely to drift due to potential reputation costs), and to changes in market conditions between the time funds were raised and funds are invested. Other forms of covenants are discussed in Gompers and Lerner (1996;1999), Litvak (2004aLitvak ( , 2004b), Lerner and Schoar (2004) for US evidence, and Schmidt and Wahrenburg (2003) and Cumming and Johan (2005) for international evidence. ...
... Research on the structure of venture capital funds is consistent with the view VCLPs are the most appropriate structure for the financing of entrepreneurship and innovation in most areas of venture capital (Gompers and Lerner, 1996;1999;Schmidt and Wahrenburg, 2003;Cumming and Johan, 2006). As we showed in Table 6.2, these venture capital funds are owned by the individual investment professionals and make contracts (VCLPs) with third party investors. ...
... Bankman and Cole (2001) study the underlying reasons for venture capital investments in a period where companies were overvalued and suggest that avoiding a loss of reputation on the PEO's side may have been one of them. Finally, Schmidt and Wahrenburg (2003) examine the effects of the reputation and bargaining power of PEOs on the design of partnership agreements. However, none of all these articles analyzes how PEOs establish their reputation in their relationship with investors, and this is the main contribution of this paper. ...
... Thus, by signaling their reputation PEOs contribute to reducing the problems of information asymmetry. In fact, as Schmidt and Wahrenburg (2003) point out, reputation can be seen as a security given by the agent to the principal. We agree with Rosenstein et al. (1990) that reputation can be linked to track record. ...
... As indicated by Smith (1999) and Schertler (2002), PEOs strive to establish a good reputation in order to attract investors to their funds. In fact, reputation determines the ability of managers to raise funds in developed private equity markets (Norton, 1995;Gompers and Lerner, 2001b;Janney and Folta, 2003;Schmidt and Wahrenburg, 2003). This should also be expected in developing countries. ...
In the light of the Agency and Signalling Theories, the aim of this paper is to analyse the relationship between investors and private equity managers in order to identify the factors that affect the latter's reputation. Since there are no individual references about their past returns, the reputation of such players is thought to be linked to their capacity for obtaining new funds in countries such as Spain. Two groups of variables that might affect reputation are identified: variables in the first group are linked to the private equity cycle, and those in the second are related to the external image of the operator. The analysis focuses on the activity of almost all private equity investors operating in Spain during 1991-2001. The results provide evidence that the size of the funds under management and the belonging to the National Private Equity Association are exogenous characteristics of the highest importance. Evidence of the volume of investments recorded in the past acts as an indicator of the ability to manage larger amounts of capital. Because of the wide variety of private equity firms, the analysis is completed for diverse groups, which may behave in a different manner.
... Second, the venture capital literature addressing the structuring of funds has approached the issue as primarily a private sector activity. While the structuring of a venture capital fund has been analysed from several perspectives, including the compensation and incentives of fund managers (Cooper and Carleton, 1979;Gompers and Lerner, 1999;Schmidt and Wahrenburg, 2003), the structuring of fund agreements (Brophy and Haessler, 1994), the structures of relationships (e.g. Sahlman, 1990;Wright and Robbie, 1998), and the use of covenants in venture partnership agreements (Gompers and Lerner, 1996), these studies typically assume that all limited partners (LPs) invest on equal terms (i.e. ...
... The investors are legally constrained from a direct involvement in the operation of the fund in order to secure preferential tax advantages. Thus, full autonomy over investment activity is given to them despite the general partners typically providing no more than 1% of the fund's total committed capital (Gilson, 2003;Sahlman, 1990;Schmidt and Wahrenburg, 2003). ...
... To align the interests of LP and GPs, in a typical fund structure the compensation of the GP is highly dependent on the commercial success of the fund. The GP typically receives of a 20% share of the net capital gain of the fund (Litvak, 2004;Sahlman, 1990;Schmidt and Wahrenburg, 2003). This participation by the GP in the investment returns is known as 'carried interest'. ...
Policy makers have become increasingly concerned at the lack of risk capital available to new and early-stage entrepreneurial ventures. As a public response to a perceived market failure, several governments have set up programs to channel equity finance to capital constrained but high potential, young enterprises. Critically, government support is often directed through the agency of private venture capital funds. We examine the profit distribution and compensation structures used in these hybrid public/private funds. We appraise government policy makers’ ability to use these structures to improve the expected returns in market failure areas in order to attract private sector investors and professional managers to participate in these funds. The results derived from our simulation study suggest that such asymmetric profit sharing models can only resolve relatively modest market failures unless the programs also manage to attract highly competent investors who are able to produce above average gross returns in market failure areas.
... Bankman and Cole (2001) study the underlying reasons for venture capital investments in a period where companies were overvalued and suggest that avoiding a loss of reputation on the PEO's side may have been one of them. Finally, Schmidt and Wahrenburg (2003) examine the effects of the reputation and bargaining power of PEOs on the design of partnership agreements. However, none of all these articles analyzes how PEOs establish their reputation in their relationship with investors, and this is the main contribution of this paper. ...
... Thus, by signaling their reputation PEOs contribute to reducing the problems of information asymmetry. In fact, as Schmidt and Wahrenburg (2003) point out, reputation can be seen as a security given by the agent to the principal. We agree with Rosenstein et al. (1990) that reputation can be linked to track record. ...
... As indicated by Smith (1999) and Schertler (2002), PEOs strive to establish a good reputation in order to attract investors to their funds. In fact, reputation determines the ability of managers to raise funds in developed private equity markets (Norton, 1995;Gompers and Lerner, 2001b;Janney and Folta, 2003;Schmidt and Wahrenburg, 2003). This should also be expected in developing countries. ...
This paper analyzes the relationship between investors and private equity managers in order to identify the factors that affect the latter's reputation. Since there are no individual references about their past returns in developing private equity markets, the reputation of such players is thought to be linked to their capacity for obtaining new funds. Results provide evidence of the volume of investments recorded in the past, the ratio of portfolio companies to investment manager, the percentage of divestments carried out through initial public offerings and trade sales, the membership of the national private equity association and the size of funds under management as characteristics of the highest importance in raising funds.
... To the best of our knowledge, there are only seven papers related to several aspects linked to this relationship. These analyse the procedures used by investors and PEOs to reduce conflicts stemming from the agency relationship (Sahlman, 1990); the phenomenon known as grandstanding, whereby younger venture capital firms tend to take their portfolio companies public earlier than older ones in order to build a reputation that will allow them to raise future funds (Gompers, 1996); the determinants of venture capital fundraising in the United States (Gompers and Lerner, 1998a); the need by PEO's to highlight how painstaking they are in their work (Osnabrugge, 2000; Osnabrugge and Robinson, 2001); the loss of reputation faced by PEOs with investors when they do not make any investment (Bankman and Cole, 2001); and the impact that both the reputation and the bargaining power of PEOs have on the design of contracts (Schmidt and Wahrenburg, 2003). However, none of these papers analyse the mechanisms whereby PEOs establish their quality, and this is the main contribution of this paper. ...
... As information on PEO's track record is limited in developing private equity markets, a proxy for management quality is needed in these markets. In developed private equity markets, the ability to attract funds depends on the manager's reputation (Norton, 1995; Gompers and Lerner, 2001b; Janney and Folta, 2003; Schmidt and Wahrenburg, 2003). One would expect this to be the same in developing countries, so the annual volume of funds raised by PEOs may be a proxy for management quality. ...
The aim of this paper is to analyse the relationship between investors and private equity managers in maturing markets. Due to the lack of information regarding track record in these markets, private equity managers should signal their quality by other means in order to raise new funds from investors. The Agency and Signalling Theories is set as theoretical frame-work to infer the relevant determinants in this context. Two groups of variables that might sig-nal quality are proposed, namely, variables related to the investment/divestment behaviour and to organisational characteristics of the operator. The empirical analysis is based on the activity of almost all private equity investors operating in Spain during the period 1991-2001. Results show that the lagged volume of investments acts as a main indicator of the ability to manage larger amounts of capital. The exogenous characteristics of highest importance are the belong-ing to the national private equity association and the size of the funds under management.
... In developed VC markets, the ability to attract funds depends on the manager's reputation. (Gompers and Lerner, 2001; Schmidt and Wahrenburg, 2003). It remains to be tested, however, if the VCs with larger sums under management add more value, allowing us to test the following hypothesis: H2: The larger the amount of funds under management, the better the performance of the portfolio firm. ...
... In developed VC markets, the ability to attract funds depends on the manager's reputation. (Gompers and Lerner, 2001; Schmidt and Wahrenburg, 2003). It remains to be tested, however, if the VCs with larger sums under management add more value, allowing us to test the following hypothesis: However, the value added is related to the attention paid by venture managers to each portfolio firm. ...
Previous research has already addressed the issue of the impact of venture capital (VC) backing on the growth patterns of investee firms. Based on qualitative, hand-collected data, other studies analyzed the different tasks performed by venture capitalists (VCs) to add value to their portfolio companies. The aim of this paper is to provide evidence of the effect of some VCs' characteristics on the performance of the portfolio firms over time. The findings are based on panel data of quantitative variables on a highly representative sample of VC investments in Continental Europe. This approach allows us to keep track of the changes over time and to control for the effect of the money invested and the value added by VCs separately. Our findings show that value added is significant in companies at the expansion stage for some VCs characteristics, such as age, size or number of portfolio companies per investment manager, whereas performance on start-up companies seems related to funding alone.
... Bankman and Cole (2001) suggest that PEOs' loss of reputation with investors may be one of the possible reasons why investments take place in a period when companies are overvalued. Finally, Schmidt and Wahrenburg (2003) analyse the impact that both the reputation and the bargaining power of PEOs have on the design of contracts. ...
... Thus, the main aim in this paper is to find evidence of PEOs' sending signals, both costly and costless, that might be considered by investors when evaluating the reputation of PEOs. In developed private equity markets, the ability to attract funds depends on the managers' reputation (Norton, 1995; Gompers and Lerner, 2001b; Janney and Folta, 2003; Schmidt and Wahrenburg, 2003). As indicated by Smith (1999) and Schertler (2002), PEOs strive to establish a good reputation in order to attract investors to their funds. ...
In the light of the Agency and Signalling Theories, the aim of this paper is to analyse the relationship between investors and private equity managers in order to identify the factors that affect the latter's reputation. Since there are no individual references about their past returns, the reputation of such players is thought to be linked to their capacity for obtaining new funds in countries such as Spain. Two groups of variables that might affect reputation are identified: variables in the first group are linked to the private equity cycle, and those in the second are related to the external image of the operator. The analysis focuses on the activity of almost all private equity investors operating in Spain during 1991-2001. The results show that the lagged volume of investments acts as an indicator of the ability to manage larger amounts of capital. The exogenous characteristics of highest importance are the size of the funds under management and the belonging to the National Private Equity Association. Because of the wide variety of private equity firms, the analysis is completed for diverse groups, which may behave in a different manner. En este artículo se analiza la relación que se origina entre inversores y operadores decapital riesgo dentro del marco de las Teorías de Agencia y de Señales. La finalidad esidentificar los factores que determinan la reputación de estos operadores. Ante la ausenciade referencias individuales de rentabilidad, la reputación puede representar un elementobásico para señalar la capacidad para captar nuevos fondos en países en los que el mercadode capital riesgo está en proceso de maduración. Dos grupos de variables que puedenafectar a la reputación son identificados: uno relacionado con la actividad desarrolladay otro vinculado a aspectos externos. El análisis se centra en la actividad de la prácticatotalidad de operadores de capital riesgo activos en España durante el periodo 1991-2001.Los resultados muestran que el volumen de inversiones registrado en el pasado indica unacapacidad para gestionar una cifra superior de capitales. Las características exógenasde mayor importancia son el tamaño del operador y la pertenencia a la AsociaciónNacional de Capital Riesgo. Dada la gran variedad de operadores existentes en España,el análisis se completa para diferentes subgrupos que podrían comportarse de distintamanera, encontrándose evidencia en este sentido.
... 6 Much of the existing research on private equity focuses on the developed economies. For example, Schmidt and Wahrenburg (2004) consider the relationship between investors and European VC-funds, considering the effects of reputation, bargaining power, and contractual design. However, recently, scholars are beginning to examine the impact of private equity on entrepreneurial activity in developing markets. ...
We develop a formal game-theoretic analysis of the economic (value-adding abilities) and behavioural factors (empathy, emotional excitement, passion) affecting a development bank’s choice of private-equity partner when investing into emerging market entrepreneurship. Triple-sided moral hazard (TSMH) problems occur in the form of effort-shirking, since the bank, the PE-manager, and the entrepreneur all contribute to value-creation. The bank’s investment choices are crucially affected by a) the relative abilities and the potential level of empathy, excitement and passion that may be generated between a PE-manager and an entrepreneur, and b) the personal emotional attachment that the bank develops towards a PE. The severity of TSMH increases inefficiencies in decision-making. Finally, we consider, in addition to political risk mitigation, an additional impact that the bank may have on PE/E value-creation: the bank may have a coaching/mentoring role. Our analysis has implications for academics and practitioners alike.
... A GP usually receives about 20 % of a fund's net profits (Sahlman 1990;Litvak 2004;Huang et al. 2005;Johan and Najar 2011). In addition, before being allowed to receive any earnings, GPs are often contractually obliged to return the total capital invested to the LPs, plus the preferred return required by investors estimated as between 7 and 9 %, called the ''hurdle rate'' (Gompers and Lerner 1999;Schmidt and Wahrenburg 2003;Cheung and Corrado 2009;Metrick and Yasuda 2010). GPs usually receive an annual management fee of about 2-2.5 % of the total committed capital of the private equity fund. ...
Private equity managers’ compensation is a particularly problematic area in terms of its tax treatment in the United States and some European countries. This problem originates from the difficulty of defining the particular forms of incentive and therefore their estimated fair value. Based on the literature, carried interest, which is one of the most common profit-sharing arrangements observed in practice, may be considered as an option characterized by several constraints. The use of classical option-pricing models is inappropriate for taking all these constraints into account. The contribution of this paper is to propose a suitable model to estimate the expected compensation of fund managers and to test the effect of fund characteristics and profit-sharing rules on its fair value. We use the Monte Carlo simulation model and take into account the non-marketability criteria of the carried interest. A sensitivity analysis is performed in order to show the evolution of the carried interest value. The results importantly show the sharp differences between carried interest distributed in the case of venture capital and that in the case of buyout funds and show the importance of the claw-back clause for “deal by deal funds”.
... Mayer , Schoors and Yafeh ( 2005 ) investigate the funds raising process in various countries . Schmidt and Wahrenburg ( 2003 ) report that reputational effects of venture capitalists are a major deter - minant of contractual relations between European VC funds and their investors . Unlike our paper , these studies do not investigate VC performance directly . ...
... This participation by the GP in the investment returns is known as 'carried interest'. Before being allowed to participate in any capital distribution, GPs are often contractually required to return the LPs' total drawn-down capital with usually a minimum agreed level of interest, i.e. the 'hurdle rate' (Gompers and Lerner, 1999;Schmidt and Wahrenburg, 2003). Once the hurdle is met, the GP 'catches up' the distributed profits of LPs by receiving all of the capital gains until the agreed carry ratio has been reached, e.g. ...
Policy makers guiding national enterprise and innovation policies have become increasingly concerned at the lack of venture (risk) capital available to new and early stage entrepreneurial ventures. At the end of the first decade of the 21 st Century, the proportion of capital allocated by private, financial institutions to early stage venture capital (VC) has continued to decline to record lows across the advanced Western economies. Similarly, smaller emerging economies (e.g. Poland and the former Soviet satellite countries) have also experienced increased rationing in the supply of private venture capital from either domestic or foreign private investors. Observers rationalise the present trend with reference to the impact of a number of market failures that impede the efficient supply and allocation of risk capital finance. In marked contrast, in the BRIC nations (Brazil, Russia, India, China), foreign investors' interest is running (perhaps imprudently) at record levels. This sometimes 'breakneck' pace of development is occurring in countries where the internal venture capital infrastructure and the wider entrepreneurial and innovation ecosystems commonly remain rudimentary and under-developed. As a public response to a perceived supply-side market failure, several governments have set up equity co-investment programmes to channel equity finance (VC) to capital constrained but high potential, young enterprises. This paper summarises Western experience in public/private (hybrid) VC programmes, notably in the UK, the USA and Australia. It reflects on the lessons learned from independent academic evaluations in order to produce a set of generic guidelines for policy makers. These guidelines are then used to look briefly at the rapidly emerging VC sectors in both China and Poland where national governments have intervened decisively in an attempt to influence the speed and direction of the domestic VC industry's development. The authors conclude that a 'policy surge' that has financed with significant public funds the rapid genesis of a nascent VC industry is in danger of wasting considerable funds if an equivalent focus and effort is not also applied simultaneously to improving key elements of the entrepreneurial and innovation ecosystems. Given potential disparities between research findings and extant policy actions, we implicitly raise the question of whether or not the governments of rapidly developing nations really can learn from developed nations' experiences.
... d Sembenelli (2006) study the evolution of aggregate VC investments in fourteen European countries as a function of policy measures and find a significant impact of the creation of stock markets geared to entrepreneurial firms and of capital gains taxations. Mayer, Schoors and Yafeh (2005) investigate the funds raising process in various countries. Schmidt and Wahrenburg (2003) report that reputational effects of venture capitalists are a major determinant of contractual relations between European VC funds and their investors. Unlike our paper, these studies do not investigate VC performance directly. There has also been a recent literature studying the returns of private equity and VC from an asset pricing pe ...
... Contrary to this idea, Gompers and Lerner (1999) found that reputational concerns induce younger partnerships to work hard to achieve success. A further explanation for a possible negative influence is provided by Schmidt and Wahrenburg (2004). They argue that managers of established funds are older and closer to retirement and therefore put less weight on the effects of their actions on future business opportunities. ...
The stepwise allocation of capital from an investor to a company is described as staging. The importance of staging as a mechanism to control an investment and to affect its success has been confirmed uniformly by several authors. But the findings on the direction of the influence of staging on investment performance have created a not yet solved puzzle. To measure this influence precisely we create a unique dataset by merging the Venture Economics and CEPRES * databases. We analyze 712 matched Private Equity and Venture Capital investments including 1.549 financing rounds and 2.329 precisely dated cash injections. We take a new approach by segmenting the post-investment period in three phases of equal lengths and analyzing the influence of staging on the overall investment performance for each of these investment phases. Our findings shed light on the bright and dark side of staging. Our results show that during the initial investment phase, the investor uses staging foremost as monitoring instrument to mitigate agency problems and to provide added-value resources to the company resulting in significant positive influence on the investment performance. Staging has little impact on performance during the maturity phase. However, during the pre-exit phase we find evidence that investment managers face a termination dilemma and do not rigorously use staging as an option to terminate unsuccessful investments in time. They rather use staging for the attempt to turn around critical situations and partially for window dressing purposes. By this staging behaviour they throw good money after bad.
... d Sembenelli (2006) study the evolution of aggregate VC investments in fourteen European countries as a function of policy measures and find a significant impact of the creation of stock markets geared to entrepreneurial firms and of capital gains taxations. Mayer, Schoors and Yafeh (2005) investigate the funds raising process in various countries. Schmidt and Wahrenburg (2003) report that reputational effects of venture capitalists are a major determinant of contractual relations between European VC funds and their investors. Unlike our paper, these studies do not investigate VC performance directly. There has also been a recent literature studying the returns of private equity and VC from an asset pricing pe ...
This paper compares the success of venture capital investments in the United States and in Europe by analyzing individual venture-backed companies and the value generated within the stage financing process. We document that US venture capitalists generate significantly more value with their investments than their European counterparts. We find differences in contracting behavior, such as staging frequency and syndication, and evidence that they help to explain the observed performance gap and we report a substantial unexplained residual. We find that US venture funds investing in Europe do not perform better their European peers. European Common Law and Civil Law countries exhibit comparable levels of venture performance, and differences in stock market development or tax subsidies in favor of venture investments are unrelated to performance differences. European IPO exits from venture investments yield returns similar to the US, while trade sale exits weakly underperform. We attribute the overall performance gap essentially to the segment of poorly performing companies.
... PEFs to invest in concert Schmidt and Wahrenburg (2004) and acknowledge extensive monitoring rights for investors. The rational is that a good PEF manager should be more willing to accept restrictive conditions than a bad manager, 1 though, later investigations of private placement memorandums reveal that although the quality of GPs diers signicantly, the contracts they write are very similar Schmidt and Wahrenburg (2004). According to (Gompers and Lerner, 1999) this is because PEFs want to avoid signaling their quality. ...
Reputation is essential to mitigate agency problems in the relationship between private equity investors and fund managers. Fund managers have to build reputation over time. Thus, lacking reputation is a major market entry barrier for new fund managers. I theoretically investigate how three types of intermediaries may support first-time funds in their fundraising by signaling the funds' quality. The problem is that these intermediaries act at the expense of investors and fund managers while maximizing their reputation and compensation. I develop recommendations which intermediary type to choose in different market environments.
... Schmidt (2003) ...
Recourse to independent directors by private equity investors is not tied to performance increases. We draw this conclusion from analyzing a unique data set representative of the European context: all deals made by Italian closed-end funds from 1999 to 2003. Our study shows, in fact, that corporate governance does not impact the rate of return on a deal. Performance, instead, is driven by the characteristics of an initiative (exit-way, holding period and shareholding). Further, we find that independent directors are involved in deals requiring greater skills and know-how. They tend to resign when performance is unsatisfactory. Moreover, these professionals improve deal performance if their commitment with the management company lasts throughout the deal and if there is a continual turnover of these directors.
... This is surprising, given the paramount importance of fund structures to understanding private equity and venture capital finance (Sahlman, 1990;Lerner, 1999, 2001). To date, there have only been four empirical studies, and three of which are derived from data exclusively from the US (Gompers and Lerner, 1996;Lerner and Schoar, 2004;Litvak, 2004a), and one with European data (Schmidt and Wahrenburg, 2003). There is no prior evidence directly comparing Europe to the US, and/or to any other countries. ...
"This paper introduces a new dataset from 50 private investment funds from 17 countries around the world. We analyse the frequency of use of investment covenants imposed by institutional investors governing the activities of private investment fund managers in areas pertaining to investment decisions, investment powers, types of investments, fund operations and limitations on liability. While the data indicate a role for country legality in affecting the frequency of use of fund covenants, the data further indicate that the presence of legally trained managers has a more pronounced role in affecting the use of covenants. As private equity and venture capital investment increases across Europe and elsewhere, our results indicate that legal practice factors will matter more than the legal setting for the establishment of covenants governing new funds." Copyright 2006 The Authors Journal compilation (c) 2006 Blackwell Publishing Ltd.
... It is noteworthy that the average frequency of use of covenants in non-US VC partnerships is unrelated to the supply and demand of venture capital. Schmidt and Wahrenburg (2003) show that established European funds are more severely restricted by the use of three sub-categories of covenants within VC-partnership agreements. An international comparison of contractual covenants among private investment funds across countries also indicates a significant difference in probability of use of covenants (Cumming and Johan 2006).Figure 2 shows the distribution of use of covenants of international VC-partnership agreements. ...
This article examines the existing contractual arrangements and industry standards in private equity. It shows that investors
are, in principle, capable of structuring their particular investments according to their own preferences, there are a range
of governance problems and risks that could be potentially hazardous for some classes of investors. We examine the circumstances
where existing industry codes and legal tools can be used to address the problems that arise in relation to private equity
and buyout activity.
KeywordsPrivate equity–Regulation
... Contrary to this idea, Gompers and Lerner (1999) argue that reputational concerns induce younger partnerships to work hard to achieve success. A further explanation for a possible negative influence is provided by Schmidt and Wahrenburg (2004). They argue that managers of established funds are older and closer to retirement and therefore put less weight on the effects of their actions on future business opportunities. ...
Previous papers that examined investment decisions by private equity funds are divided on whether staging has a positive or negative effect on returns. We believe these opposing views can be reconciled by studying when staging is used during the life of the investment relationship: We find that staging has a positive effect on investment returns in the beginning of the investment relationship, consistent with the notion that staging helps mitigate information asymmetry. However, staging appears to be negatively associated with returns when used prior to the exit decision. Our unique dataset allows us to measure these intertemporal effects precisely.
Résumé Cet article compare les performances des investissements en capital risque aux États-Unis et en Europe au regard de la valeur créée au cours du cycle d’investissement par les entreprises financées par ces fonds en capital risque. Nous montrons que les entreprises financées par des investisseurs américains créent significativement plus de richesse que celles financées par des investisseurs européens. Nous trouvons des différences dans les contrats, notamment sur la fréquence des rounds d’investissement et sur la création de syndicats, et montrons que celles-ci expliquent partiellement les différences de performances. Nous trouvons aussi que les investisseurs américains investissant en Europe n’obtiennent pas de meilleures performances que les investisseurs européens. Les entreprises de pays européens ayant un système juridique de « Common Law » et celles de pays ayant un système juridique codifié obtiennent des performances similaires. De même, le développement des marchés financiers et des aides à l’investissement en capital risque n’ont pas d’impact sur les performances. Les richesses crées par les entreprises dont les investisseurs sont sortis lors d’une introduction en bourse sont identiques des deux cotés de l’Atlantique. Par contre, concernant les sorties lors de ventes de gré à gré, les entreprises européennes sous-performent les entreprises américaines. De manière globale, la sous-performance des investissements en capital risque en Europe relativement aux États-Unis est attribuée au segment des entreprises ayant obtenus des mauvaises performances.
In an optimal carried interest model with adverse selection, the optimal profit-loss sharing ratio (PSR) explains how the risk aversion of the two parties can affect their bargaining powers by allowing investors to detect the true risk aversion of the fund manager and not his true skills. The higher the management fee, the higher is the PSR. Our simulation exercise shows that when the fund manager is more risk averse than the investor for a higher invested capital and weaker expected net profit, the optimal negotiated profit-sharing ratio will be higher.
This work analyses the efficacy of two regulatory changes on private equity fundraising. In particular. the efficacy of changes in the capital gains tax and the introduction of a new legislation regulating private equity activity are analysed. Considering the population of private equity institutions in Spain during the period 1991-2007. the results show the effectiveness of the introduction of specific regulation intended to limit double taxation and provide confidence to investors. On the contrary. no firm evidence is found about the effect of a reduction of the tax in capital gains at the personal income tax. maybe due to the indirect relationship with the demand for private equity. These results are important to the regulator since they show the effectiveness of several measures aimed It contributing to the development of private equity markets.
This work analyses the efficacy of two regulatory changes on private equity fundraising. In particular, the efficacy of changes in the capital gains tax and the introduction of a new legislation regulating private equity activity are analysed. Considering the population of private equity institutions in Spain during the period 1991-2007, the results show the effectiveness of the introduction of specific regulation intended to limit double taxation and provide confidence to investors. On the contrary, no firm evidence is found about the effect of a reduction of the tax in capital gains at the personal income tax, maybe due to the indirect relationship with the demand for private equity. These results are important to the regulator since they show the effectiveness of several measures aimed at contributing to the development of private equity markets.
IntroductionRelated LiteratureA Simulation Approach for Venture Capital Performance Projection and Risk ManagementSimulation Results for Two Fictitious Venture Capital FundsConclusion
NotesAbout the Authors
IntroductionInstitutional Investment: Motivations and BehaviorStructure and StrategiesPerformanceConclusion
NotesAbout the Author
The present paper addresses the Law and Economics of Green Investment (Green Shares) in the specific field of green mutual funds, and analyzes the principal agent problem that exists between the single investor and the green fund manager, suggesting regulation and optimal contracting clauses in order to reduce and minimize the conflict of interests and asymmetric information inherent to the relationship. The first chapter introduces and establishes the concept of Green investment (Green shares). The second chapter focuses on the market instruments of Green Investment, outlining mutual funds, as well as pension funds, private equity and hedge funds. Empirical data is presented, dealing mainly with fund performance and effects of remuneration schemes and covenants. The third chapter covers the legal background of mutual funds and correlated market instruments of green investment in Europe, the UK and the USA, in both hard and soft law areas. The last chapter presents the Principal Agent Problem, with normative suggestions of new regulation and contracting possibilities in the area of Green Mutual Funds.
This paper introduces a new dataset from 50 private investment funds from 17 countries in Africa, North and South America, Europe and Australasia. We analyze compensation in regards to fixed management fees (as a percentage of fund size), performance fees (the carried interest percentage), clawbacks (reduced fees for poor performance), and cash versus share distributions (payment to institutional investors). We control for a variety of factors including market conditions, institutional investor and fund manager characteristics, including education and experience as well as fund factors such as stage and industry focus, among other control variables available in the new detailed international dataset. The data indicate that legal conditions by far have the most robust statistically and economically significant effect on compensation across countries: fixed fees are higher and performance fees are lower in countries with poor legal conditions; clawbacks are more likely in countries with poor legal conditions; and cash-only distributions are much more likely to be mandated among offshore funds.
The paper analyses the effects of three sets of accounting rules for financial instruments - Old IAS before IAS 39 became effective, Current IAS or US GAAP, and the Full Fair Value (FFV) model proposed by the Joint Working Group (JWG) - on the financial statements of banks. We develop a simulation model that captures the essential characteristics of a modern universal bank with investment banking and commercial banking activities. We run simulations for different strategies (fully hedged, partially hedged) using historical data from periods with rising and falling interest rates. We show that under Old IAS a fully hedged bank can portray its zero economic earnings in its financial statements. As Old IAS offer much discretion, this bank may also present income that is either positive or negative. We further show that because of the restrictive hedge accounting rules, banks cannot adequately portray their best practice risk management activities under Current IAS or US GAAP. We demonstrate that - contrary to assertions from the banking industry - mandatory FFV accounting adequately reflects the economics of banking activities. Our detailed analysis identifies, in addition, several critical issues of the accounting models that have not been covered in previous literature.
Previous research on reporting and disclosure in private equity (buyout and venture capital) has primarily focused on describing the contractual clauses between portfolio company, fund manager and fund investor, and on explaining its origin in terms of more general economic concepts. In comparison, we look at the actual reporting behaviour and information flow of the private equity (mainly venture capital) fund manager to the fund investors, based on access to a fund investor's database. Our findings should not only be of interest to the fund investor with respect to good investment monitoring and portfolio management, but also be useful to get an intimate look at the often hidden underlying dynamics of the private equity fund industry, like information flow, and to observe the actual implementation of the contractual clauses on reporting. Overall, we find that the European private equity industry has improved their reporting qualitatively and quantitatively, especially in terms of shorter delivery times of reports. We attribute this change mainly to the introduction of the EVCA reporting guidelines and a willingness by both, fund managers and investors, to report voluntary or contractually bind by contract to report in accordance to these standards. Information flow has become faster during the last years but it still takes on average more than four months for information to travel from the portfolio company to the fund investor's database. Fund characteristics like experience, stage and focus also affect the reporting behaviour. For example, mid market funds, first time funds and non audited reports have a lower reporting frequency than venture capital, non first time funds or audited reports. On the other hand, audited reports take significantly longer to get to the fund investor. We also point out that aspects of the relationship between the entrepreneur and fund manager are also often found at the next level, between fund managers and investors.
This study investigates the role of credit rating agencies in international financial markets. With an index of speculative market pressure it is analyzed whether sovereign ratings changes have an impact on the financial stability in emerging market economies. The event study analysis indicates that sovereign rating changes have substantial influence on the size and volatility of emerging markets lending. The empirical results are significantly stronger in the case of government's downgrades and negative imminent rating actions than in the case of agencies’ positive rating adjustments. Sovereign rating changes anticipated by market participants have a smaller impact on financial markets in emerging economies.
In this article, we investigate risk return characteristics and diversification benefits when private equity is used as a portfolio component. We use a unique dataset describing 642 US-American portfolio companies with 3620 private equity investments. Information about precisely dated cash flows at the company level enables for the first time a cash flow equivalent and simultaneous investment simulation in stocks, as well as the construction of stock portfolios for benchmarking purposes. With respect to the methodology involved, we construct private equity, stock-benchmark and mixed-asset portfolios using bootstrap simulations. For the late 1990s we find a dramatic increase in the extent to which private equity outperforms stock investment. In earlier years private equity was underperforming its stock benchmarks. Within the overall class of private equity, returns on earlier private equity investment categories, like venture capital, show on average higher variations and even higher rates of failure. It is in this category in particular that high average portfolio returns are generated solely by the ability to select a few extremely well performing companies, thus compensating for lost investments. There is a high marginal diversifiable risk reduction of about 80% when the portfolio size is increased to include 15 investments. When the portfolio size is increased from 15 to 200 there are few marginal risk diversification effects on the one hand, but a large increase in managing expenditure on the other, so that an actual average portfolio size between 20 and 28 investments seems to be well balanced. We provide empirical evidence that the non-diversifiable risk that a constrained investor, who is exclusively investing in private equity, has to hold exceeds that of constrained stock investors and also the market risk. From the viewpoint of unconstrained investors with complete investment freedom, risk can be optimally reduced by constructing mixed asset portfolios. According to the various private equity subcategories analyzed, there are big differences in optimal allocations to this asset class for minimizing mixed-asset portfolio variance or maximizing performance ratios. We observe optimal portfolio weightings to be between 3% and 65%.
In Germany a public discussion on the "power of banks" has been going on for decades now with the term "power" having at least two meanings. On the one hand, it denotes the power of banks to control public corporations through direct shareholdings or the exercise of proxy votes – this is the power of banks in corporate control. On the other hand, the market power derived from imperfect competition in markets for financial services is implied, which banks exercise vis-à-vis their loan and deposit customers. In the past, bank regulation has often been blamed for undermining competition and the functioning of market forces in the financial industry for the sake of soundness and the stability of financial services firms. This chapter tries to shed some light on the historical development and current state of bank regulation in Germany. In so doing, it tries to embed the analysis of bank regulation in a more general industrial organization framework. For every regulated industry, competition and regulation are deeply interrelated as most regulatory institutions, even if they do not explicitly address the competitiveness of the market, affect either market structure or conduct. This paper aims to uncover some of the specific relationships between monetary policy, government intervention and bank regulation on the one hand and bank market structure and economic performance on the other. We hope thereby to be able to point the way to several areas for fruitful research in the future. While our focus is on Germany, some of the questions that we raise and some of our insights might also be applicable to banking systems elsewhere.
In Study 1, over 200 college students estimated how much their own chance of experiencing 42 events differed from the chances of their classmates. Overall, Ss rated their own chances to be significantly above average for positive events and below average for negative events. Cognitive and motivational considerations led to predictions that degree of desirability, perceived probability, personal experience, perceived controllability, and stereotype salience would influence the amount of optimistic bias evoked by different events. All predictions were supported, although the pattern of effects differed for positive and negative events. Study 2 with 120 female undergraduates from Study 1 tested the idea that people are unrealistically optimistic because they focus on factors that improve their own chances of achieving desirable outcomes and fail to realize that others may have just as many factors in their favor. Ss listed the factors that they thought influenced their own chances of experiencing 8 future events. When such lists were read by a 2nd group of Ss, the amount of unrealistic optimism shown by this 2nd group for the same 8 events decreased significantly, although it was not eliminated. (22 ref) (PsycINFO Database Record (c) 2012 APA, all rights reserved)
We estimate a small model of the euro area to be used for evaluating alternative monetary policy strategies. Starting with the relationship between output and inflation we compare the fit of the nominal wage contracting model due to Taylor (J. Political Econom. 88 (1980) 1) and the relative real wage contracting model proposed by Buiter and Jewitt (The Manchester School 49 (1981) 211; reprinted in Buiter (Ed.), Macroeconomic Theory and Stabilization Policy, Manchester University Press, Manchester, 1989) and estimated with U.S. data by Fuhrer and Moore (Quart. J. Econom. 110 (1995) 127). While Fuhrer and Moore reject nominal contracts in favor of relative contracts, which induce more inflation persistence, we find that both specifications fit euro area data reasonably well. When considering France, Germany and Italy separately, however, we find that nominal contracts fit German data better, while the relative contracting model does well with respect to formerly high inflation countries such as France and Italy. We close the model by estimating an aggregate demand relationship and investigate the implications of nominal versus relative contracts for the inflation-output variability tradeoff when monetary policy follows Taylor's rule.
In this study, we perform a quantitative assessment of the role of money as an indicator variable for monetary policy in the euro area. We document the magnitude of revisions to euro area-wide data on output, prices, and money, and find that monetary aggregates have a potentially significant role in providing information about current real output. We then proceed to analyze the information content of money in a forward-looking model in which monetary policy is optimally determined subject to incomplete information about the true state of the economy. We show that monetary aggregates may have substantial information content in an environment with high variability of output measurement errors, low variability of money demand shocks, and a strong contemporaneous linkage between money demand and real output. As a practical matter, however, we conclude that money has fairly limited information content as an indicator of contemporaneous aggregate demand in the euro area.
Many prominent theorists have argued that accurate perceptions of the self, the world, and the future are essential for mental health. Yet considerable research evidence suggests that overly positive self-evaluations, exaggerated perceptions of control or mastery, and unrealistic optimism are characteristic of normal human thought. Moreover, these illusions appear to promote other criteria of mental health, including the ability to care about others, the ability to be happy or contented, and the ability to engage in productive and creative work. These strategies may succeed, in large part, because both the social world and cognitive-processing mechanisms impose filters on incoming information that distort it in a positive direction; negative information may be isolated and represented in as unthreatening a manner as possible. These positive illusions may be especially useful when an individual receives negative feedback or is otherwise threatened and may be especially adaptive under these circumstances.
The private equity market has become an important source of funds for start-up firms, private middle-market firms, firms in financial distress, and public firms seeking buyout financing. Between 1980 and 1994, the amount of private equity outstanding rose from less than 100 billion. Despite the market's extraordinary growth and its importance to many types of firms, it has received little attention in the financial press or the academic literature. ; This study examines the economic foundations of the private equity market and discusses in detail the market's organizational structure. Drawing on publicly available data and extensive fieldwork, it describes the major issuers, intermediaries, investors, and agents in the market and their interactions with each other. It examines the reasons for the market's explosive growth over the past fifteen years and highlights the main characteristics of that growth. Finally, the study provides data on returns to private equity investors and analyzes the major secular and cyclical influences on returns. ; The study emphasizes two major themes. One is that the growth of private equity is a classic example of the way organizational innovation, aided by regulatory and tax changes, can ignite activity in a particular market. In this case, the innovation was the widespread adoption of the limited partnership. Until the late 1970s, private equity investments were undertaken mainly by wealthy families, industrial corporations, and financial institutions that invested directly in issuing firms. Much of the investment since 1980, by contrast, has been undertaken by professional private equity managers on behalf of institutional investors. The vehicle for organizing this activity is the limited partnership, with the institutional investors serving as limited partners and investment managers as general partners. ; The emergence of the limited partnership as the dominant form of intermediary is a result of the extreme information asymmetries and potential incentive problems that arise in the private equity market. The specific advantages of limited partnerships are rooted in the ways in which they address these problems. The general partners specialize in finding, structuring, and managing equity investments in closely held private companies. Because they are among the largest and most active shareholders, partnerships have significant means of exercising both formal and informal control, and thus they are able to direct companies to serve the interests of their shareholders. At the same time, partnerships use organizational and contractual mechanisms to align the interests of the general and limited partners. ; The second theme of the study is that the growth of the private equity market has expanded access to outside equity capital for both classic start-up companies and established private companies. Some observers have characterized the growth of non-venture private equity as a shift away from traditional venture capital. They attribute the shift of investment funds to several factors, including the presence of large institutional investors that do not want to invest in small funds or small deals, a change in the culture of private equity firms, and a decline in venture opportunities. Although these factors may have played a role, the argument that non-venture private equity has driven out venture capital seems insupportable, as both types of investment have grown rapidly. We argue that the increase in non-venture private equity investment has been due principally to an abundance of profitable investment opportunities. Moreover, the available data on returns on private equity investments indicate that during the 1980s, non-venture investing generated higher returns than did venture investing, suggesting that private equity capital has flowed to its most productive uses.
Using a sample of forty-nine countries, the authors show that countries with poorer investor protections, measured by both the character of legal rules and the quality of law enforcement, have smaller and narrower capital markets. These findings apply to both equity and debt markets. In particular, French civil law countries have both the weakest investor protections and the least developed capital markets, especially as compared to common law countries. Coauthors are Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert W. Vishny. Copyright 1997 by American Finance Association.
This paper constructs a model of saving for retired single people that includes heterogeneity in medical expenses and life expectancies, and bequest motives. We estimate the model using Assets and Health Dynamics of the Oldest Old data and the method of simulated moments. Out-of-pocket medical expenses rise quickly with age and permanent income. The risk of living long and requiring expensive medical care is a key driver of saving for many higher-income elderly. Social insurance programs such as Medicaid rationalize the low asset holdings of the poorest but also benefit the rich by insuring them against high medical expenses at the ends of their lives. (c) 2010 by The University of Chicago. All rights reserved..
This paper develops a theory of financial intermediation based on minimizing the cost of monitoring information which is useful
for resolving incentive problems between borrowers and lenders. It presents a characterization of the costs of providing incentives
for delegated monitoring by a financial intermediary. Diversification within an intermediary serves to reduce these costs,
even in a risk neutral economy. The paper presents some more general analysis of the effect of diversification on resolving
incentive problems. In the environment assumed in the model, debt contracts with costly bankruptcy are shown to be optimal.
The analysis has implications for the portfolio structure and capital structure of intermediaries.
The mark of a capitalistic society is that resources are owned and allocated by such nongovernmental organizations as firms, households, and markets. Resource owners increase productivity through cooperative specialization and this leads to the demand for economic organizations which facilitate cooperation. When a lumber mill employs a cabinetmaker, cooperation between specialists is achieved within a firm, and when a cabinetmaker purchases wood from a lumberman, the cooperation takes place across markets (or between firms). Two important problems face a theory of economic organization – to explain the conditions that determine whether the gains from specialization and cooperative production can better be obtained within an organization like the firm, or across markets, and to explain the structure of the organization. It is common to see the firm characterized by the power to settle issues by fiat, by authority, or by disciplinary action superior to that available in the conventional market. This is delusion. The firm does not own all its inputs. It has no power of fiat, no authority, no disciplinary action any different in the slightest degree from ordinary market contracting between any two people. I can “punish” you only by withholding future business or by seeking redress in the courts for any failure to honor our exchange agreement. That is exactly all that any employer can do. He can fire or sue, just as I can fire my grocer by stopping purchases from him or sue him for delivering faulty products.
In this paper we draw on recent progress in the theory of (1) property rights, (2) agency, and (3) finance to develop a theory of ownership structure for the firm.1 In addition to tying together elements of the theory of each of these three areas, our analysis casts new light on and has implications for a variety of issues in the professional and popular literature, such as the definition of the firm, the “separation of ownership and control,” the “social responsibility” of business, the definition of a “corporate objective function,” the determination of an optimal capital structure, the specification of the content of credit agreements, the theory of organizations, and the supply side of the completeness-of-markets problem.
Two separate groups of academics have brought about a renaissance of sorts in the analysis of incomplete contracts. Law and economics scholars—writing in law reviews—have shown renewed interest in how efficiency-minded lawmakers should fill gaps in incomplete contracts. Yet even before this, a group of economists—writing in economics journals—began developing new theories of "incomplete contracting" that are still largely unincorporated in the legal literature. These two strands of analysis have remained largely independent, in part because they focus on two different forms of contractual incompleteness.
The private equity market is an important source of funds for start-up firms, private middle-market firms, firms in financial distress, and public firms seeking buyout financing. Over the past fifteen years it has been the fastest growing corporate finance market, by an order of magnitude over the public equity and public and private bond markets. Despite its dramatic growth and increased significance for corporate finance, the private equity market has received little attention. This study examines the economic foundations of the private equity market, analyzes its development and current role in corporate finance, and describes the market's institutional structure. It examines the reasons or the market's explosive growth over the past fifteen years and highlights the main characteristics of that growth. It provides data on returns to private equity investors and analyzes the major secular and cyclical influences on returns. It describes the important investors, intermediaries, issuers, and agents in the market and their interactions with each other. Drawing on data from trade journals, the study also estimates the market's size as of year-end 1995.
Recent scholarship has described a venture capital cycle which finances start-up technology companies. This cycle, however, bears striking similarities with its counterpart in the old economy under which banks financed young firms. Indeed, with one notable exception, venture capital has introduced little innovation in financial contract design between financial intermediaries and entrepreneurs. The same approaches to information problems are used by banks and venture capital partnerships alike. The significant exception is the frequent use in venture capital finance of convertible instruments in the place of secured debt financing by banks. This paper explains (i) the functional similarity between venture capital and bank contracts with entrepreneurs and (ii) the valuable role played by convertible debt or preferred stock in technology start-ups.
For years, researchers have hypothesized that new ventures develop in a fairly predictable chronological process by evolving through various functional and strategic developmental stages. However, cross-comparable longitudinal data from large numbers of ventures are still not available to validate these “stages of development” hypotheses. The study sought to determine whether venture capital firms, which have extensive experience with the longitudinal development of new ventures, operate in accord with a common theory about how this process operates. These findings also represent a first step toward empirically validating various elements of “stages of development” theories.
This paper integrates elements from the theory of agency, the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm. We define the concept of agency costs, show its relationship to the ‘separation and control’ issue, investigate the nature of the agency costs generated by the existence of debt and outside equity, demonstrate who bears these costs and why, and investigate the Pareto optimality of their existence. We also provide a new definition of the firm, and show how our analysis of the factors influencing the creation and issuance of debt and equity claims is a special case of the supply side of the completeness of markets problem.The directors of such [joint-stock] companies, however, being the managers rather of other people's money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master's honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.Adam Smith, The Wealth of Nations, 1776, Cannan Edition(Modern Library, New York, 1937) p. 700.
Venture-capital organizations raise money from individuals and institutions for investment in early-stage businesses that offer high potential but high risk. This paper describes and analyzes the structure of venture-capital organizations, focusing on the relationship between investors and venture capitalists and between venture-capital firms and the ventures in which they invest. The agency problems in these organizations and to the contracts and operating procedures that have evolved in response are emphasized. Venture-capital organizations are contrasted with large, publicly traded corporations and with leveraged buyout organizations.
This paper analyzes a comprehensive data set of 108 non venture-backed, 58 venturebacked and 33 bridge financed companies going public at Germany s Neuer Markt between March 1997 and March 2000. I examine whether these three types of issues differ with regard to issuer characteristics, balance sheet data or offering characteristics. Moreover, this empirical study contributes to the underpricing literature by focusing on the complementary or rather competing role of venture capitalists and underwriters in certifying the quality of a company when going public. Companies backed by a prestigious venture capitalist and/or underwritten by a top bank are expected to show less underpricing at the initial public offering (IPO) due to a reduced ex-ante uncertainty. This study provides evidence to the contrary: VCbacked IPOs appear to be more underpriced than non VC-backed IPOs.
Im Wirtschaftsleben bilden sich laufend neue Formen der Zusammenarbeit und neue Vertragstypen heraus. Zu einem guten Teil sollen diese neuen Kooperationsdesigns geeignet sein, Probleme zu bewältigen, die sich aus Informationsunterschieden der Partner ergeben. In diesem Aufsatz sollen drei Grundtypen asymmetrischer Information herausgearbeitet werden (Qualitätsunsicherheit, Holdup, Moral Hazard), und es soll gezeigt werden, welche Formen der Kooperation und welche Vertragstypen jeweils als adäquat oder "typisch" angesehen werden dürfen (Offenbarung, Autorität, Anreizsysteme). Die entwickelte Typenlehre kann auch dem Praktiker Hinweise geben, wann die eine oder andere Form asymmetrischer Information zu vermuten ist und welche Wege zur Bewältigung der sich aus den Informationsunterschieden ergebenden Nachteile offenstehen.
Eine weite Klasse von Modellen bewertet eine Unternehmung anhand der Erträge, Überschüsse oder Zahlungen, die sie in Zukunft für die Berechtigten generiert. Je nach Modell haben die erzeugten Zahlungen die Bedeutung von Dividenden, Gewinnen, Freien Cashflows oder von Excess Returns, weshalb jede Bewertung als Erstes eine Wahl des Ansatzes voraussetzt. Hier bieten sich das Dividenden-Wachstums-Modell, eine Ertragsbewertung, der DCF-Ansatz oder eine Bewertung anhand der Residualeinkommen. Wenn der Ansatz gewählt und die Zahlungen der Art nach spezifiziert sind, wird als Zweites eine Vorschau der Zahlungen für alle kommenden Jahre erstellt. Selbstverständlich muss diese Vorschau auf geeignete Weise die mutmaßliche Höhen und die jeweiligen Unsicherheiten der zukünftigen Zahlungen erfassen sowie ihre gegenseitigen stochastischen Abhängigkeiten. Hinweise dafür bieten die Geschäftsplanung der betreffenden Unternehmung und die Prognose der allgemeinen Wirtschaftsentwicklung, von der die Unternehmung abhängig ist. Diese Planungen und Prognosen münden in eine Folge unsicherer Zahlungen, Z̃1,Z̃2 Z̃3, deren Wahrscheinlichkeitsverteilungen typischerweise von der allgemeinen Wirtschaftsentwicklung abhängen. Im dritten Schritt der Bewertung muss der Wert der unsicheren Zahlungsreihe Z̃1,Z̃2 Z̃3,... ermittelt werden.1 Für diesen dritten Schritt wird oft eine „vereinfachte Diskontierung“ (simplified discounting rule) verwendet.
In diesem Abschnitt geht es darum, alternative soziale Institutionen (konkret: Versicherungsgesellschaften, Geld sowie persönliche Bindungen) zu diskutieren, die als Substitut für solche Kontrakte dienen können, welche aufgrund individuell rationalen “unmoralischen” Verhaltens (dem Ausnutzen von Informationsvorteilen) nicht zustande kommen können.
This paper examines covenants in 140 partnership agreements establishing venture capital funds. Despite the similar objectives and structures of these funds and the relatively limited number of contracting parties, the agreements are quite heterogenous in their inclusion of covenants. We examine two complementary hypotheses that suggest when covenants will be used. Covenant use may be determined by the extent of potential agency problems: because covenants are costly to negotiate and monitor, they will only be employed when these problems are severe. Alternatively, covenant use may reflect the supply and demand conditions in the venture capital industry. The price of venture capital services may shift if the demand for venture funds changes while the supply of fund managers remains fixed in the short run. The evidence suggests that both factors are important. This is in contrast to previous studies which have either focused exclusively on costly contracting or provided only weak support for the effects of supply and demand on contracts.
August 28, 1997
A firm's reputation is considered an important asset. I develop a model in which a firm's only asset is its name -- which is associated with its reputation -- and study the economic forces which cause names to be valuable, tradeable assets. A simple adverse selection model together with an assumption on the non-observability of shifts of ownership guarantees that in equilibrium the market for names is active. This result is robust to both finite and infinite horizons, in contrast to standard results in the reputation literature. I also show that situations in which only good types buy names with a good reputation cannot be sustained in equilibrium.
Theoretical work on the principal-agent problem in financial contracting focuses on the conflicts of interest between an agent / entrepreneur with a venture that needs financing, and a principal / investor providing funds for the venture. Theory has identified three primary ways that the investor / principal can mitigate these conflicts - structuring financial contracts, pre-investment screening, and post-investment monitoring and advising. In this paper, we describe recent empirical work and its relation to theory for one prominent class of principals venture capitalists (VCs). The empirical studies indicate that VCs attempt to mitigate principal-agent conflicts in the three ways suggested by theory. The evidence also shows that contracting, screening, and monitoring are closely interrelated. In screening, the VCs identify areas where they can add value through monitoring and support. In contracting, the VCs allocate rights in order to facilitate monitoring and minimize the impact of identified risks. Also, the equity allocated to VCs provides incentives to engage in costly support activities that increase upside values, rather than just minimizing potential losses. There is room for future empirical research to study these activities in greater detail for VCs, for other intermediaries such as banks, and within firms.
This paper was presented at the World Congress of the Econometric Society, Cambridge, Massachusetts, 1985
This paper surveys recent research on venture capital and suggests directions for future research. There is new empirical evidence in the field, and new theoretical models have resolved some issues. The paper selectively examines recent findings, particularly models and empirical work about staging of financing, the use of syndicates, the process of screening investments, and participation by venture capitalists in IPOs. Finally, the paper identifies some of the remaining issues for which new research is needed.
The book provides a comprehensive and up-to-date overview of all aspects of the German financial system, grounded in the current discussion about the importance of a country's financial system for its economic development. The common starting points for the book as a whole as well as for all 15 individual chapters are what the respective authors perceive as peculiarities of the German financial system and the perception that seems to prevail among foreign observers of this system.
The book covers a wide range of topics from the banking system, the stock exchanges, bank–client relationships, regulation and competition in the financial sector to corporate governance and financial accounting in Germany.
Principal-agent models are studied, in which outcomes conditional on the agent's action are uncertain, and the agent's behaviour
therefore unobservable. For a model with bounded agent's utility, conditions are given under which the first-best equilibrium
can be approximated arbitrarily closely by contracts relating payment to observable outcomes. For general models, it is shown
that the solution may not always be obtained by using the agent's first-order conditions as constraint. General conditions
of Lagrangean type are given for problems in which contracts are finite-dimensional.
We analyze incomplete long-term financial contracts between an entrepreneur with no initial wealth and a wealthy investor.
Both agents have potentially conflicting objectives since the entrepreneur cares about both pecuniary and non-pecuniary returns
from the project while the investor is only concerned about monetary returns. We address the questions of (i) whether and
how the initial contract can be structured in such a way as to bring about a perfect coincidence of objectives between both
agents (ii) when the initial contract cannot achieve this coincidence of objectives how should control rights be allocated
to achieve efficiency? One of the main results of our analysis concerns the optimality properties of the (contingent) control
allocation induced by standard debt financing.
In a duopoly model of informed speculation, the authors show that overconfidence may strictly dominate rationality since an overconfident trader may not only generate higher expected profit and utility than his rational opponent but also higher than if he were also rational. This occurs because overconfidence acts like a commitment device in a standard Cournot duopoly. As a result, for some parameter values the Nash equilibrium of a two-fund game is a prisoner's dilemma in which both funds hire overconfident managers. Thus, overconfidence can persist and survive in the long run. Copyright 1997 by American Finance Association.
This paper examines the structure of staged venture capital investments when agency and monitoring costs exist. Expected agency costs increase as assets become less tangible, growth options increase, and asset specificity rises. Data from a random sample of 794 venture-capital-backed firms support the predictions. Venture capitalists concentrate investments in early stage and high technology companies where informational asymmetries are highest. Decreases in industry ratios of tangible assets to total assets, higher market-to-book ratios, and greater R&D intensities lead to more frequent monitoring. Venture capitalists periodically gather information and maintain the option to discontinue funding projects with little probability of going public. Copyright 1995 by American Finance Association.
Venture capital limited partnerships are an attractive arena to study cross-sectional and time-series variations in compensation schemes. We empirically examine 419 partnerships. The compensation of new and smaller funds displays considerably less sensitivity to performance and less variation than that of other funds. The fixed base component of compensation is higher for younger and smaller firms. We observe no relation between incentive compensation and performance. Our evidence is consistent with a learning model, in which the pay of new venture capitalists is less sensitive to performance because reputational concerns induce them to work hard.
Venture capital investing differs in important respects from investment decisions involving the securities of Fortune 500 companies, or decisions to purchase established companies, which are generally made in accord with widely recognized financial models. Investing in new ventures involves a high level of uncertainty as well as a high risk of failure. Venture capital investing is characterized by high variability in the outcomes of new ventures and in the performance of venture capital portfolios.
This paper develops a model of firm/union bargaining in which bargaining is repeated. If contracts specify the values of all variables of interest, a player's share of the surplus will decrease as that player becomes more impatient, but impatience has a much weaker effect than in static games. When the contracts do not specify the values of all relevant variables, this result can be reversed and the firm's bargaining power could become greater as it becomes more impatient.
Inflation-targeting central banks have only imperfect knowledge about the effect of policy decisions on inflation. An important source of uncertainty is the relationship between inflation and unemployment. This paper studies the optimal monetary policy in the presence of uncertainty about the natural unemployment rate, the short-run inflation-unemployment tradeoff and the degree of inflation persistence in a simple macroeconomic model, which incorporates rational learning by the central bank as well as private sector agents. Two conflicting motives drive the optimal policy. In the static version of the model, uncertainty provides a motive for the policymaker to move more cautiously than she would if she knew the true parameters. In the dynamic version, uncertainty also motivates an element of experimentation in policy. I find that the optimal policy that balances the cautionary and activist motives typically exhibits gradualism, that is, it still remains less aggressive than a policy that disregards parameter uncertainty. Exceptions occur when uncertainty is very high and in inflation close to target.
At least from the time of Ricardo, economists have begun their investigations of how competitive markets work, how wages, rents and prices are determined, by a detailed examination of agriculture. Even today, agriculture is taken as the paradigm-and perhaps almost the only important example-of a truly competitive market (or at least this was the case until the widespread government intervention in this market). For a number of years I have been concerned with how competitive markets handle risk taking, and how risk affects real resource allocation. Risks in agriculture are clearly tremendously important, yet remarkably the traditional theoretical literature has avoided explicit treatment 3 of risk sharing in agricultural environments. The consequences of this are important. First, it makes suspect the traditional conclusions regarding sharecropping. Is it really true that sharecropping results in too low a supply of labour, because workers equate their share of output times the (value of the) marginal productivity of labour to the marginal disutility of work, whereas Pareto optimality requires the (value of the) marginal productivity of labour be equal to the marginal disutility of work? Or is it true, as Wicksell asserted, that there is no distincion between landlords hiring labour or labour renting land? Second, it leaves unanswered many of the important economic questions. How is the equilibrium share determined? Why have some economies (in the past or at present) used one distribution system, other economies used others? Our object is to formulate a simple general equilibrium model of a competitive agricultural economy. (Other general equilibrium models of competitive economies with uncertainty have been formulated by Arrow [2] and Debreu [9], Diamond [10], and Stiglitz [14]. Each of these has its serious limitations in describing the workings of the modern capitalist economy. (See Stiglitz [15]).) The model is of interest not only for extending our understanding of these simple economies but also in gaining some insight into the far more complex phenomena of shareholding in modern corporations. Our focus is on the risk sharing and incentive properties of alternative distribution systems. The analysis is divided into two parts. In the first, the amount of labour (effort) supplied by an individual is given, and the analysis focuses on the risk sharing aspects of
The author develops a model in which a firm's only asset is its name, which summarizes its reputation, and studies the forces that cause names to be valuable, tradable assets. An adverse selection model in which shifts of ownership are not observable guarantees an active market for names with either finite or infinite horizons. No equilibrium exists in which only good types buy good names. The reputational dynamics that emerge from the model are more realistic than those in standard game-theoretic reputation models and suggest that adverse selection plays a crucial role in understanding firm reputation.
Venture Capital Contracts around the world, unpublished preliminary draft of working paper
- Kaplan
- N Steven
- Martel
- Frederic
- Strömberg
Kaplan, Steven N. / Martel, Frederic / Strömberg, Per (2002) Venture Capital Contracts around the world, unpublished preliminary draft of working paper.
Private Equity Fund Structures in Europe
- J Blake
Blake, J. et al. (1999), Private Equity Fund Structures in Europe, EVCA Europe Special Paper.
EVCA Yearbook European Venture Capital Association
EVCA (2001), EVCA Yearbook 2001, European Venture Capital Association.
What do Economists tell us about Venture Capital Contracts, Working Paper Zentrum für Europäische Wirtschaftsforschung
- T Tykvova
Tykvova, T. (2000), What do Economists tell us about Venture Capital Contracts,
Working Paper Zentrum für Europäische Wirtschaftsforschung, Mannheim.
- K Spremann
Spremann, K (1990), Asymmetrische Information, in: Zeitschrift für
Betriebswirtschaft, Vol. 59, pp. 561-589.
The Venture Capital Handbook
- J Brooks
Brooks, J (1999), Fund-Raising and the Investor Relations, in: Bygrave/Hay/Peeters
(Hrsg. 1999), The Venture Capital Handbook.
The Arthur Young Guide to Financing for Growth
- R R Owen
- R D Gardner
- D S Bunder
Owen, R.R./ Gardner, R.D. / Bunder, D.S., The Arthur Young Guide to Financing for
Growth, New York 1986.