Risk, Self Selection and Advice: Banks Versus Venture Capitalists
23 Pages Posted: 4 Mar 2002
Date Written: February 27, 2002
Abstract
Venture capital has produced an impressive track record in recent years. But the industry is very focused on specific industries and special types of companies. The paper analyses this market separation between bank financed and venture capital backed companies. I find that both venture capitalist and entrepreneur prefer to finance risky projects using venture capital while secure ones should use ordinary bank finance. Distortion in this positive self-selection process is caused by an overinvestment mechanism which allows some low quality entrepreneurs to profit from the venture capitalist's advice. This in turn provides incentives for him to use screening.
JEL Classification: D82, G24, L11
Suggested Citation: Suggested Citation
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