The Value of Benchmarking

Dirk Bergemann and Ulrich Hege

No 1379, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

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 (search for similar items in EconPapers)
JEL-codes: D83 D92 G24 G31 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2002-08, Revised 2002-10
New Economics Papers: this item is included in nep-ent and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Working Paper: The Value of Benchmarking (2004)
Working Paper: The value of benchmarking (2002)
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