Browsing by Subject "Entrepreneurial finance"

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Empirical essays on agency problems in venture capital
(2023) Koenig, Lukas; Burghof, Hans-Peter
In the first essay, we explore the potential agency conflict between limited partners and general partners in venture capital firms due to changes in investment style. Investment style refers to the characteristics of a venture capital funds portfolio, such as the portfolio companies stage of development, location, and industry. While investment style can significantly impact the risk and return profile of a fund, it is usually not explicitly agreed upon by limited and general partners. We argue that changes in investment style, known as style drifts, can reveal information about the risk-taking behavior of venture capitalists and present empirical evidence in support of this claim. To determine whether style drifts constitute an agency conflict, we consider two sets of hypotheses. The first set posits that style drifts are intentional decisions to take on more risk, potentially driven by incentives related to compensation or employment. The second set suggests that style drifts may occur because of competitive pressure and may not necessarily be indicative of an intent to increase risk. Our findings suggest that style drifts are likely to create an agency conflict, as the evidence supports the hypothesis that well-performing venture capitalists increase investment risk to benefit from higher compensation potential via carried interest when they feel confident, they will be able to raise a follow-on fund securing their base income via management fees. Additionally, we examine the impact of style drifts on individual investments and fund performance and find that overall, style drifts hurt a funds exit rate, indicating the potential for increased risk. In the second essay, we examine the relationship between venture capitalists and entrepreneurs, specifically focusing on the role of information asymmetry in the funding process. Using text classification and text mining techniques we analyze the content and level of detail in capital allocation plans provided by entrepreneurs to investors, which serve as a proxy for private informational updates that are typically not widely available. Our analysis shows that investors do consider the content and specificity of these updates when making valuation decisions and that both positive information signals and more detailed information are related to higher valuations. We also investigate the effect of the relative level of information asymmetry between venture capitalists and entrepreneurs on the value of these updates, finding that they are more impactful in situations where there is a higher level of information asymmetry. The results of our study have practical implications for entrepreneurs, as we find that the negative impact of negative information signals can be offset by providing highly specific information and that the value of an informational update is influenced by the existing level of information asymmetry. In the third essay, I explore the impact of university affiliations on the initial matching process between venture capitalists and founders, the involvement of the investor during the funding relationship, and the eventual startup performance and investment exit success. University affiliations can influence the funding relationship through two channels: first, attending a top university may serve as a signal of founder quality to venture capitalists, helping them to avoid adverse selection; second, shared alumni networks may establish trust and reduce information asymmetry between otherwise unknown individuals. Using a dataset of 42,101 investments involving 38,452 unique venture capitalists and founders, I find that educational ties between venture capitalists and founders have a positive effect on the funding relationship, including the initial matching, the level of involvement of the investor during the funding relationship, and the eventual startup performance and investment exit success. The effect of sharing an educational background between a venture capitalist and a founder is about five times larger than the effect of a founder attending a top university. Further, the results also show that educational ties are more valuable the more exclusive they are, and that redundant ties between the founding team and the investors have diminishing value for the investment decision.