Scandinavian Working Papers in Economics

Working Paper Series in Economics and Institutions of Innovation,
Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies

No 349: A SIGNALING THEORY OF ENTREPRENEURIAL VENTURE’S VALUATION: EVIDENCE FROM EARLY TERMINATION OF VENTURE CAPITAL INVESTMENT

Ali Mohammadi (), Mohammadmehdi Shafizadeh () and Sofia Johan ()
Additional contact information
Ali Mohammadi: CESIS - Centre of Excellence for Science and Innovation Studies, Royal Institute of Technology, Postal: CESIS - Centre of Excellence for Science and Innovation Studies, Royal Institute of Technology, SE-100 44 Stockholm, Sweden
Mohammadmehdi Shafizadeh: Management, Economics and Industrial Engineering, Politecnico di Milano
Sofia Johan: Schulich School of Buisiness, York University.

Abstract: This paper investigates how early termination of venture capital (VC) investment in entrepreneurial ventures affect the ability of these young ventures into acquiring further resources necessary for survival and growth. We propose that young entrepreneurial ventures face a higher cost of external financing if existing investors stop investing in the next rounds of financing. Future investors, faced with great unobservable qualities of young companies and the uncertainty surrounding their financial prospect, rely on observable characteristics to appraise a company; The continuation of investment by existing investors confers a positive signal about the quality of young ventures and that young ventures, as endorsed by further commitment of capital, are more likely to perform better than otherwise comparable ventures that lack such escalated commitment.

Keywords: Information Asymmetry; Signaling Theory; Venture Capital; Discontinued Investment

JEL-codes: D80; G24

41 pages, March 12, 2014

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