Journal of Economic Theory and Econometrics: Journal of the Korean Econometric Society

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Journal of Economic Theory and Econometrics
Journal of the Korean Econometric Society

The Reputation Effects on Investment Behavior of Venture Capital Firms

Vol.17, No.4, December , 1–23

English Version |  Korean Version
  •   (Dongguk University)


Koran venture capital firms possess two sources for investments, their own fund and the limited partnership fund raised with outside investors. Due to this fact, the literature argues that venture capital firms will show opportunistic investment behavior, i.e., supplying the external fund into relatively riskier startups. Furthermore, the literature predicts that such investment behavior weakens the outside investor's incentive for participating in venture funds. However, such prediction fails to explain currently increasing trend of sizes and numbers of external funds. Noting that external funds are in general formed and then liquidated repeatedly over time, this article develops the two period model in which investments are undertaken repeatedly. It shows that the repetition of formation and expiration of funds acts as an implicit contract, which creates the reputation effect, thereby enhancing the outside investor's incentive for supplying their capital into fund. In particular, a low ability venture capital firm may concern its reputation so that it replicates the investment pattern of a high ability venture capital firm. Thus, this effect may hinder the venture capital firm's opportunistic investment behavior, and can promote outside investor's incentive for participating in formation of venture fund.

   Sources of Fund, Information Asymmetry, Reputation Effect, Implicit Contract

JEL classification codes
   D82, G24

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