Signaling Mechanism In The Exiting Of Venture Capital Investment

In the recent 10 years, many successful companies are growing under the support ofventure capitals. Venture capital financing concentrates in the very short initial stageof the development of a company, a characteristics that makes it very important forventure capitalists whether they can "exit" successfully. However, the asymmetricinformation about the quality of the invested company between the two sides of thetransaction when venture capitalists try to "exit" through selling their shares to outerinvestors will seriously impede the effective pricing of such transactions. Thus, howto resolve this problem becomes a vital issue for the development of the industry ofventure capital financing.Existing researches focus on the relation between entrepreneurs and venturecapitalist, which has a main influence on the designing of financial contracts. Someempirical literatures explored the exiting problem of venture capital, but no integratetheoretical model concerning the filtering and incentive function of the exitingmechanism of venture capital has been built. My research, which employs mechanismdesign and game theory, will be an explorer in this field, hoping to improve ourunderstanding the signaling process in venture capital industry and to intrigue furtherdiscussions.In the paper, I first build a signaling game with efficient filtering and incentivemechanisms to "solve" the asymmetric information problem between venturecapitalist and outer investors. The "signal" in our model is the "locked" share of theventure capitalist after the invested company's IPO. I find that under some strictassumptions about the information structure and moving sequences of the model,there will be an optimal "lock up" percentage for a venture capitalist, which will beused by outer investors as a filtering tool to distinguish "good" and "bad" companieswhile at the same time provides the venture capitalist with highest possible liquidity.Then I expand the model into different sets of information structures, making it bettersimulate the real world situation. I also expand the game into an infinite repeated one,in which we find the importance of REPUTATION to the venture capital industry.In the end, I use my model in to the application of explain China's venture capitalinvest market and find that the reasons for the blooming of foreign venture capitalistsand the generally underperforming of local venture capitalists are rooted in thereputation that foreign venture capitalists have already built up and the inefficientinformation and investor structure in China's capital market.The proposal for the government to enhance China's venture capital industry isopposite to the popular opinions. Our analysis indicates that given the informationstructure which is in lack of fundamental information and full of technical information,and the investor structure which is composed mainly with speculators, the widelyproposed setting up of a "NASDAQ in China" will only do harm to the local venturecapital industry by increasing speculative investments, which will result in inefficientallocation of social capital.