Les Cahiers de Recherche - HEC Paris
Ulrich HEGE and Dirk BERGEMANN
The value of benchmarking
Abstract: We consider the provision of venture capital in a dynamic
model with multiple research stages, where time and investment needed to
meet each benchmark are unknown. The allocation of funds is subject moral
hazard. The optimal contract provides for incentive payments linked to
attaining the next benchmark, which must be increasing in the funding
horizon of each stage. Benchmarking reduces agency costs, directly by
shortening the agent's guaranteed funding horizon, and indirectly via an
implicit incentive effect of information rents in future financing rounds.
The ex ante need to provide incentives and the venture capitalist's desire
to cut information rents ex post create a hold-up conflict, which can be
overcome by providing all funds in every stage in a single up-front
payment. Empirical patterns of the evolution of financing rounds and
research intensity over the lifetime of a project are explained as optimal
choices: the optimal capital allocated and the funding horizon are
increasing from one stage to the next. This emphasizes the notion that
early stages are the riskiest in an innovative venture.
Keywords: venture financing; optimal stopping; benchmarking; stage financing; abandonment option; (follow links to similar papers)
JEL-Codes: D83; D92; G24; G31; (follow links to similar papers)
30 pages, April 1, 2002
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