Venture Capital Budgeting - Carry and Correlation

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Abstract

We analyze venture capital budgeting in a model with agency conflicts among entrepreneurs, venture capitalists, and investors. Our three-player setting is crucial for the analysis of compensation to venture capitalists. We focus on the venture capitalist's decision to invest in correlated enterprises, and we emphasize the importance of information and the venture capitalist's role in resolving adverse selection on the entrepreneurial side. The importance of information increases the minimum carried interest offered to the venture capitalist, whereas correlated projects decrease it. The carried interest is determined by the size and level of correlation in his portfolio. Our analysis provides predictions in line with a number of empirical observations, e.g. that venture capitalists typically receive a carried interest which is "sticky" around a 20% level. [U+25BA] We analyze a venture capitalist's (VC's) decision to invest in correlated projects. [U+25BA] We focus on the VC's role as an information intermediary. [U+25BA] Importance of information increases the minimum carried interest offered to the VC. [U+25BA] Correlated projects decrease the minimum carried interest offered to the VC. [U+25BA] We explain why venture capitalists typically receive a "sticky" carried interest.

Original languageEnglish
JournalJournal of Corporate Finance
Volume21
Pages (from-to)216-234
ISSN0929-1199
DOIs
Publication statusPublished - 1. Jun 2013

Keywords

  • Corporate finance
  • Venture capital
  • Asymmetric information
  • Staging
  • Carry
  • Adverse selection
  • Moral hazard

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