JournalofCorporateFinance10(2004)131–

155

www.1mpi.com

Stagedfinancinginventurecapital:

moralhazardandrisks

SushengWanga,*,HailanZhoub

aDepartmentofEconomics,HongKongUniversityofScienceandTechnology,ClearWaterBay,HongKong

bJohnsonSchoolofManagement,CornellUniversity,Ithaca,NY14850,USA

Received1May2002;receivedinrevisedform3June2002;accepted25July2002

Abstract

Thispaperinvestigatesstagedfinancinginanenvironmentwhereanentrepreneurfacesanimperfectcapitalmarketandaninvestorfacesmoralhazardanduncertainty.Stagedfinancingplaystworolesinthismodel:tocontrolriskandtomitigatemoralhazard.Usingparametricfunctionsandcomparingstagedfinancingwithupfrontfinancing,wediscoverafewinterestingpropertiesofstagedfinancing.Inparticular,weshowthatwhenusedtogetherwithasharingcontract,stagedfinancingactsasaneffectivecomplementarymechanismtocontractingincontrollingagencyproblems.

D2002ElsevierScienceB.V.Allrightsreserved.

JELclassification:G24;G31;G34

Keywords:Stagedfinancing;Venturecapital;Moralhazard;Risk

1.Introduction

Stagedfinancinghasbeenwidelyusedinventurecapital,especiallyintheUnitedStates.Canstagedfinancingbeusedbyventurecapitaliststoreducerisksandtocontrolmoralhazard?Canstagedfinancingimproveefficiency,especiallyforhighlypromisingfirms?

Oneprominentcharacteristicofmanynewstartupcompaniesinhigh-techindustriesisthehighriskduetothegreatuncertaintyaboutreturns,thelackofsubstantialtangibleassetsandthelackofatrackrecordinoperations.Manyhigh-techstartupsmayfacemany

*Correspondingauthor.Tel.:852-2358-7630;fax:+852-2358-2084.

E-mailaddresses:s.wang@ust.hk(S.Wang),hz35@cornell.edu(H.Zhou).

0929-1199/$-seefrontmatterD2002ElsevierScienceB.V.Allrightsreserved.doi:10.1016/S0929-1199(02)00045-7