Convertible Preferred Stock in Venture Capital Financing

Flippo Ippolito ()

OFRC Working Papers Series from Oxford Financial Research Centre

Abstract: We develop a model in which cash-constrained entrepreneurs seeks a venture capitalist (VC) to finance a new firm. Costly monitoring is employed by VCs to reduce entrepreneurial moral hazard. When monitoring reveals poor performance, VCs want to punish the entrepreneur with liquidation. However, when assets are specific and liquidation would lead to a loss, VCs choose to renegotiate the terms of financing rather than to liquidate. Renegotiation undermines the threat of liquidation. By giving VCs incentives to monitor and liquidate underperforming projects, the hybrid nature of convertible preferred stock helps reduce this problem. As potential equity holders, VCs are willing to absorb the costs of monitoring because this promotes managerial efficiency and increases expected profits. At the same time as debt holders, VCs are sheltered from loss in a liquidation because they enjoy seniority with respect to common stock holders.

Keywords: venture capital; monitoring; liquidation; convertible preferred stock; vesting (search for similar items in EconPapers)
JEL-codes: G21 G24 G32 G33 (search for similar items in EconPapers)
Pages: 34
Date: 2006
New Economics Papers: this item is included in nep-ent
References: Add references at CitEc
Citations:

Downloads: (external link)
http://www.finance.ox.ac.uk/file_links/finecon_papers/2006fe12.pdf (application/pdf)
Our link check indicates that this URL is bad, the error code is: 500 Can't connect to www.finance.ox.ac.uk:80 (No such host is known. )

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:sbs:wpsefe:2006fe12

Access Statistics for this paper

More papers in OFRC Working Papers Series from Oxford Financial Research Centre Contact information at EDIRC.
Bibliographic data for series maintained by Maxine Collett ().