| Chapter 1: A model of entrepreneurial finance (with Andrew Winton). We analyze how optimal contracting between an entrepreneur and a financial institution depends on the cash flow characteristics of the entrepreneur's firm. For firms with limited financial slack, the optimal contract resembles convertible debt only if the institution monitors actively; otherwise, debt is optimal. Convertible debt and active monitoring ("venture capital finance") are optimal only when the firm is not too profitable on average ex-ante, strategic uncertainty is high, and the firm's cash flow distribution is highly skewed, with low probability of success, low liquidation value, and high returns if successful. If these conditions are not met, debt and passive monitoring ("bank finance") are optimal.; Chapter 2: Optimal investment structure for a start-up firm: Flexibility versus incentives. A start-up firm can choose between the following two investment structures: it can make the entire investment up front ("up-front implementation"), or it can initiate only a part of the project up front, and retain the option to continue or abandon the project at a later date ("staged implementation"). I show that while the flexibility of staged implementation benefits the firm by reducing its losses if the project turns out to be unprofitable, it also hurts the manager's incentives by making her more vulnerable to being held up by the investor. I characterize the conditions under which staged implementation is optimal.; Chapter 3: Joint control and redemption rights in venture capital contracts. I analyze how control over key corporate decisions should optimally be allocated between the entrepreneur and the venture capitalist. I show that assigning control jointly to both the agents, and specifying a harsh penalty, such as liquidation, if they fail to reach an agreement, is optimal when the firm has low financial slack and a reasonable collateral value, and when the venture capitalist's liquidity constraints and cost of monitoring the firm are high. The threat of liquidation under joint control can be made credible by granting a redemption right to the venture capitalist. Such arrangements are commonly found in venture capital financed firms. |
