Private Information and Bargaining Power in Venture Capital Financing

Yrjo Koskinen

Haskayne School of Business, University of Calgary

Michael J. Rebello

University of Texas at Dallas – Naveen Jindal School of Management

Jun Wang

City University of New York, CUNY Baruch College – Zicklin School of Business – Department of Economics and Finance

February 28, 2013

Journal of Economics and Management Strategy, Forthcoming

Abstract:

We model the natural evolution of private information over the life of a venture capitalist financed project. In the early stages, the entrepreneur is better informed regarding the project, and when the project matures, the venture capitalist has an informational advantage over the entrepreneur. Within this framework, we examine how the venture capitalist’s relative bargaining power affects cash flow rights and investment. When the bargaining advantage lies with the entrepreneur, the project may not be screened, and the venture capitalist may acquiesce to excessive initial investment but subsequently terminate the project. Increased venture capitalist bargaining power encourages project screening, attenuates the incentive to overinvest, and reduces the incidence of project termination subsequent to the initial investment. The payoff sensitivity of venture capitalist’s financing contract also increases as his bargaining power improves.

Private Information and Bargaining Power in Venture Capital Financing

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