The Application of Principal-Agent Methods to Investor-Investee Relations in the UK Venture Capital Industry

Gavin Reid

CRIEFF Discussion Papers from Centre for Research into Industry, Enterprise, Finance and the Firm

Abstract: Principal-agent analysis is applied to contemporary evidence on venture capital investment. The investor (as principal) and investee (as agent) are analysed in terms of risk management, information handling and the trading of risk and information. Investors and investees were paired in 'dyads', with each party being subject to separate face-to-face interviews. The paper develops the appropriate principal-agent models for dealing with incentives for entrepreneurial effort and issues of information and monitoring. The way in which investees and investors seek contract optimality is then examined, using qualitative data. It is shown that the evidence provides striking confirmation of the applicability of the principal-agent model to the venture capital financing of mature small firms. The most crucial feature of contract optimality was perceived to be the propoer choice of capital structure. This established ownership entitlement, created incentives for effort, and apportioned risk eficiently. Many investor-investee relations were perceived to be at or close to contract optimality. These optima were specific to time and place situations and strongly reflected individual house-styles of investors. Investor reputations were strongly attached to house styles.

Keywords: principal-agent model; entrepreneurship; mature small firms; venture capital; risk-bearing; information handling; contract optimality (search for similar items in EconPapers)
JEL-codes: D21 D8 G1 G24 L2 M1 M2 M4 (search for similar items in EconPapers)
Date: 1998-10
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Related works:
Journal Article: The application of principal-agent methods to investor-investee relations in the UK venture capital industry (1999)
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