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Optimal Investment, Monitoring, and the Staging of Venture Capital



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    • Graduate School of Business Administration, Harvard University. I would like to thank Eli Berman, Robert Dammon, Joanne Dushay, Steve Kaplan, Tarun Khanna, Josh Lerner, Andrew Metrick, Mitch Petersen, Jim Poterba, Raghu Rajan, Richard Ruback, Bill Sahlman, Andrei Shleifer, Jeremy Stein, René Stulz, Rob Vishny, Luigi Zingales, two anonymous referees, and seminar participants at the 1994 Western Finance Association meetings, the Financial Decision and Control Workshop at the Harvard Business School, the Federal Reserve Bank of Chicago, the University of Illinois, and the University of Chicago for helpful comments and suggestions. Phil Hamilton provided invaluable assistance in collecting the Venture Economics data. Chris Allen provided technical assistance with COMPUSTAT. Any errors or omissions are my own. This research was funded by the Division of Research at the Graduate School of Business Administration, Harvard University and the Center for Research on Securities Prices, University of Chicago.


This paper examines the structure of staged venture capital investments when agency and monitoring costs exist. Expected agency costs increase as assets become less tangible, growth options increase, and asset specificity rises. Data from a random sample of 794 venture capital-backed firms support the predictions. Venture capitalists concentrate investments in early stage and high technology companies where informational asymmetries are highest. Decreases in industry ratios of tangible assets to total assets, higher market-to-book ratios, and greater R&D intensities lead to more frequent monitoring. Venture capitalists periodically gather information and maintain the option to discontinue funding projects with little probability of going public.

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