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Robust Financial Contracting and the Role of Venture Capitalists

Published on Jun 1, 1994in Journal of Finance
· DOI :10.1111/j.1540-6261.1994.tb05146.x
Anat R. Admati22
Estimated H-index: 22
(Stanford University),
P. Pßeiderer21
Estimated H-index: 21
(Stanford University)
Abstract
The authors derive a role for inside investors, such as venture capitalists, in resolving various agency problems that arise in a multistage financial contracting problem. Absent an inside investor, the choice of securities is unlikely to reveal all private information and overinvestment may occur. An inside investor, however, always makes optimal investment decisions if and only if he holds a fixed-fraction contract, where he always receives a fixed fraction of the project's payoff and finances that same fraction of future investments. This contract also eliminates any incentives of the venture capitalist to misprice securities issued in later financing rounds. Copyright 1994 by American Finance Association.
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