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Institute for Financial Research SIFR Research Report Series, Institute for Financial Research

No 45:
Private Information and Bargaining Power in Venture Capital Financing

Yrjo Koskinen (), Michael J. Rebello and Jun Wang ()

Abstract: We examine how the relative bargaining power of privately informed venture capitalists and entrepreneurs - determined either by market conditions or by prior experience - affects both the willingness of venture capitalists to invest and the terms of their financing contracts. Our results demonstrate that shifts in the venture capitalists' bargaining power have a profound influence both on the terms of contracts and on investments in venture-backed projects. As witnessed in the recent past, when the bargaining advantage lies with entrepreneurs, venture capitalists may acquiesce to both investing in negative NPV projects and excessive investments in early stages of projects. Further, they will subsequently terminate poor projects. An improvement in the bargaining position of venture capitalists increases the payoff sensitivity of their financing contracts. It also completely attenuates their incentive to overinvest, limiting the need for excessive project terminations arter the initial round of financing.

Keywords: Venture capital; asymmetric information; bargaining power; financial contracting; investment distortions; (follow links to similar papers)

JEL-Codes: D82; G24; G32; (follow links to similar papers)

52 pages, September 15, 2006, Revised February 8, 2011

Please find updated version on http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=105962

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Koskinen_Rebello_Wang_Feb2013.pdf    PDF-file
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This paper is forthcoming as:
Koskinen, Yrjo, Michael J. Rebello and Jun Wang, 'Private Information and Bargaining Power in Venture Capital Financing', Journal of Economics and Management Strategy.



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