Financing and Advising: Optimal Financial Contracts with Venture Capitalists


  • Catherine Casamatta

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    • University of Toulouse, CRG, and CEPR. This paper is a revised version of chapter 3 of my Ph.D. dissertation, University of Toulouse. Bruno Biais has provided invaluable advice at every stage of the paper: Special thanks to him. I am indebted to an anonymous referee and especially to Rick Green (the editor) for very useful comments and advice. Many thanks also for helpful suggestions and discussions to Sudipto Bhattacharya, Alex Gümbel, Michel Habib, Antoine Renucci, Nathalie Rossiensky, Javier Suarez, and Wilfried Zantman, as well as participants at the 1999 EEA meeting, the 1999 AFFI international meeting, the 1999 workshop on corporate finance at the University of Toulouse, the 1999 conference on Entrepreneurship, Banking and the Public Policy at the University of Helsinky, the 2000 EFMA meeting, and the 2000 ESSFM at Gerzensee. I also benefited from comments at seminars at SITE (Stockholm School of Economics), ESSEC, and HEC Lausanne.


This paper analyses the joint provision of effort by an entrepreneur and by an advisor to improve the productivity of an investment project. Without moral hazard, it is optimal that both exert effort. With moral hazard, if the entrepreneur's effort is more efficient (less costly) than the advisor's effort, the latter is not hired if she does not provide funds. Outside financing arises endogenously. This explains why investors like venture capitalists are value enhancing. The level of outside financing determines whether common stocks or convertible bonds should be issued in response to incentives.