Cannibalization & Incentives in Venture Financing

This paper develops a financial contracting setting to explore the effects of strategic substitutabilities in venture capital financing. Strategic substitutabilities between a VC’s portfolio firms may induce a VC to provide soft entrepreneurial incentive schemes in order to limit cannibalization. At the same time, however, they strengthen the credibility of termination threats imposed on poorly performing ventures. Strategic substitutabilities can thus be employed to incentivize entrepreneurs to perform (and compete) more aggressively. We demonstrate that the latter effect prevails when strategic substitutabilities are neither too small nor too large. We discuss our findings in light of case study evidence from the venture capital industry.

Playing Hardball: Relationship Banking in the Age of Credit Derivatives

This paper develops a contracting framework in order to explore the effects of credit derivatives on banks’ incentives to monitor loans, their incentives to intervene, and, ultimately, borrowers’ incentives to perform. We show that (i) credit derivatives with short term maturity strengthen incentives to intervene, incentives to monitor, and managerial incentives to perform; (ii) while credit derivatives with long term maturity weaken incentives to intervene, intervention incentives can be maintained by sourcing more short term credit insurance; (iii) long term credit insurance nevertheless weakens managerial incentives through a dilution effect. These findings suggest that properly designed credit derivatives strengthen monitoring incentives and result in efficiency gains, rather than impeding economic efficiency.

Cannibalization & Incentives in Venture Financing

This paper considers the effects of strategic substitutabilities on performance and incentives in venture capital financing. The analysis points to a subtle link between two pivotal roles of venture capitalists: (i) monitoring ventures and setting performance incentives, and (ii) coordinating and shaping the product market strategies of ventures operating in similar product spaces. When strategic substitutabilities are strong, the VC's role is to soften potentially too aggressive product market strategies. In contrast, small strategic substitutabilities can lead to more aggressive performance incentives. This is because they enhance the VC's commitment to weed out losers, which strengthens entrepreneurial incentives and results in overall efficiency gains. We discuss our findings in light of case study evidence from the venture capital industry.venture capital; strategic substitutabilities; incentives

Corporate Leverage and Product Differentiation Strategy

We explore the joint determination of product differentiation strategy and corporate leverage in a setting where (i) product differentiation is valued by customers; (ii) debt is necessary to discipline managers; and (iii) liquidation is costly for customers, in particular, when products are highly differentiated from competitors' products. We show that when managerial incentive problems call for high leverage, firms position their products closer to competitors to reduce deadweight costs customers incur in liquidation. We discuss our findings in light of case study evidence.leverage; product differentiation; liquidation costs; customer lock-in strategies; innovation

Debt and Product Market Fragility

Liquidation of a supplier of durable goods can be costly for its customers because it frequently undermines the smooth supply of after-sales service and spare parts or makes it more costly. This paper studies the interplay between capital structure and product pricing strategy when liquidation imposes costs on customers. I develop a model which illustrates that highly leveraged firms can enter a vicious circle in which financial distress and sales drops are re-enforcing. Multiple equilibria can arise. There exists a "good" equilibrium in which consumers buy and the firm is in good financial shape. However, when agency problems between investors and managers are severe, there is also "bad" equilibrium: consumers turn away from the vendor, the market collapses, and the firm goes bankrupt. Moreover, the "good" equilibrium is highly fragile in that a small shock to the firm's profits can trigger a spiral of sales drops. I show that the firm can avoid the "bad" equilibrium by cutting prices and reducing leverage.

Corporate governance and leverage: evidence from a natural experiment

We argue that the recent corporate governance reform in the Netherlands provides a natural experiment to explore the impact of changes in corporate governance on financing policy. We find that, relative to a control sample of comparable firms outside the Netherlands, Dutch firms significantly reduced their leverage following the passage of the reform. Our findings are consistent with the view that corporate governance improvements reduce the value of debt as a disciplining device

Did sox section 404 make firms less opaque? Evidence from cross-listed firms

We study whether Section 404 of the Sarbanes-Oxley Act of 2002 made cross-listed firms less opaque via an examination of analyst earnings forecasts. To test this, we compare European Union (EU) firms that are cross-listed in the US—and therefore subject to S404—with comparable EU firms that are not cross listed. We find that while both types of firms experienced a decrease in opaqueness over time, this decrease was significantly larger for cross-listed firms. Our results are robust to accounting for concurrent sell-side analyst regulations in the US, delistings, and changes in corporate risk taking. Overall, our analysis suggests that SOX had a positive effect on corporate disclosure quality