The Impact Mechanism Of Venture Capital Institutions’ Reputation On Investment Behavior

Venture capital is known as the incubator of high-tech enterprises. In addition to providing capital, venture capital institutions (VCs) contribute greatly to enterprises’ success by providing value-added services. As a result, VCs are considered as ideal sources of financing for starting and expanding high-potential companies.In recent years, a group of VCs such as Shenzhen Capital Group, have got brilliant achievements in fostering enterprises and promoting scientific and technological innovation. These institutions not only have gained a great deal of fame, but also have created fortune. The reason for their success is not far to seek-they attached great importance to improving service capacity and building reputation in order to meet the demand of stakeholders such as regulators and entrepreneurs, who are filled with the desire for value-added services.Reputation is widely recognized as a valuable intangible asset. VCs are heterogeneous and differ in reputation level. As special enterprises, the VCs will take into account fortune and fame, and try to gain them. The literature on venture capital has grown substantially, which mainly focus on the determination, measure and effect of VCs’reputation. A great many scholars were interest in studying the selection of project, writing contract, post-investment management, and other behaviors. However, few studies have focused on the effect of VCs’reputation on their behavior comprehensively and systematically.This paper discusses the following sets of questions regarding venture capital from VCs’investment process by using information asymmetry, game theory, mathematical models and econometric models. The first set of questions is about how VCs select projects or enterprises. How does VCs’reputation affect its set of potential projects? Why VCs prefer to invest in some special sectors, which have always received a great deal venture capital? What the roles does VCs’reputation play in their selection of projects? The second set of questions is about the negotiation between a venture capitalist and an entrepreneur during the contract-signing period. How does VCs’reputation affect contract-signing? How does VCs’reputation affect the allocation of ownership when they design the contract? The third set of questions is about the VCs’post-investment management of their portfolio. Why and how shall venture capitalist monitor entrepreneurs and provide value-added services to enterprises? How does VCs’reputation affect their willingness of involvement in investees? Do reputable VCs provide different services and monitoring, then gain good results compared to normal VCs? The primary objectives of the paper are to address these questions. The paper contributes to research on reputation and venture capital, and also can provide new insights on venture capitalist’behavior, give some useful advice to make reasonable decisions for VCs, enterprises, investors and other stakeholders.According to the objectives and questions above, the paper set the following research process.(1) Construct a new theoretical framework for analyzing the effect of VCs’ reputation on investment behaviors. This section uses the information theory, game theory and so on to analyze the role of reputation of VCs in economic transactions, and explore the necessity of building reputation. Then the paper presents mutual relationship of VCs’reputation and their behavior. According to Fombrun’s research result in 1990, the paper put forward a conceptual model to show the mechanism about how VCs’reputation affects their behavior. At last, a new theoretical framework for analyzing the effect of VCs’reputation on investment behavior is constructed.(2) The impact mechanism of VCs’reputation on selection of projects. This section first concerns mechanism that how VCs’reputation influences the supply of projects and how VCs’reputation relieves the constraint condition of supply of capital for investment. Then it constructs mathematic models to analyze how VCs’reputation affects their preference for some projects in special sectors. The models show that low reputation VCs will imitate the investment ways of high reputation VCs using to select project in some special sectors. It is the reason why high-tech industry can always attract a lot of venture capital. The paper also constructs mathematical models to research the impact of VCs’reputation on their process of selecting process by extending the achievement of Dewatripont & Maskin(1995).(3) The impact mechanism of VCs’reputation on writing contract. This section first analyzes the mechanism that VCs’reputation promotes writing contract, and then analyzes the role of VCs’reputation in setting items of contracts preventing entrepreneurs’moral hazard risk. The paper also studies how a VC reputation affect the allocation of equity share of enterprises between the VC and the entrepreneur using mathematical methods, which expanding from the mathematical models presented by Bettignies & Brander(2007), and drives some conclusions, for example, venture capital finance will be chosen by the entrepreneur if it dominates loans on the condition that VCs have high reputation.(4) The impact mechanism of VCs’ reputation on post-investment. This section analyzes why and how VCs involve in monitoring and providing value-added service in post-investment phase respectively, and shows the mechanism that VCs’ post-investment monitoring limits behavioral moral hazard of the entrepreneurs. The mathematical models discuss the factors influencing the willingness to involvement in enterprises’ governance or operation, and reveal why do reputable VCs actively participate in monitoring the entrepreneur and offering value-added service. Finally, an empirical analysis is conducted to provide the new evidence from Chinese GEM, regarding VCs’ reputation influences their investment performance.The innovation of this paper lies in that the research is conducted from the new standpoint in a relative new way, and may come to some new conclusions. The paper offers new interpretations on some phenomena in venture capital market.(1) Theoretically, this paper uses the information theory and game theory to present mutual relationship of VCs’ reputation and their behavior, and then utilizes Fombrun’s conceptual model to construct a new theoretical framework for analyzing the effect of VCs’ reputation on investment behaviors. It also reveals what and how does VCs’ reputation influence their behavior during the whole investment process including three continuous periods concerning selection of projects, contract, and post-investment activities, and discusses its influencing mechanism from a process perspective.(2) Innovation in research methods. This paper studies the topic by combining theoretical analysis, mathematical modeling, empirical analysis and case study method. Specially, six modified or innovative mathematical models are used to analyze special topic in context of the venture capital, which originated from the previous studies of many scholars such as Rasul & Bandiera(2006). An empirical analysis is conducted to provide the new evidence regarding VCs’ reputation influences their investment performance using unique IPO data including rate of over funding of issuers, high issue price took place in Chinese GEM.(3) Innovation in conclusions. This paper not only reveals the impact mechanism of VCs’ reputation on selecting projects, writing contract and post-investment, and also reaches some innovative conclusions from new insight, among which, what are worth mentioning is that the models in fifth section show that the VC with higher reputation can receive more ownership share from the entrepreneur, but can’t exceed 50%. The empirical results show that enterprises backed by reputable VCs can set a higher issuing price of shares and raise more capital. The paper also offers new insight into some phenomena related to VCs. By studying VCs’investment behavior from the standpoint of VCs’reputation, the paper finds the reason why high-tech industry always attract a lot of venture capital, and explains why VCs may invest some projects without a great prospect in the view of monetary benefits. From VCs’ reputation viewpoint, it provides a new explanation why the unique IPO phenomenon including rate of over funding of issuers, high issue price of shares took place in Chinese GEM but not in developed countries’securities markets.