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Evaluation frequency and evaluator’s experience: the case of venture capital investment firms and monitoring intensity in stage financing

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Abstract

In this paper we analyze the relation between an investor’s experience and the intensity of monitoring activities. Specifically, we consider venture capitalist firms and their choices of time intervals between financing rounds. We hypothesize that more industry investment experience leads to longer time intervals between financing rounds and hence, lower monitoring intensity. Using a unique data set of venture capital firms from Germany during the period from 1995 to 2005 we find evidence for our hypothesis that in a given time frame more experienced investors evaluate and monitor their investments less often than less experienced investors. In addition, VC investors pool their experience and share the risk involved in investing by forming syndicates which reduces the incentives to monitor subsequently. On the basis of our results we argue that the optimal frequency of performance evaluations should take into account the experience of the evaluator.

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Notes

  1. In what follows, we refer to venture capital and venture capitalist as VCs.

  2. Campbell and Frye (2009) distinguish high quality and low quality VCs, where quality refers to VC firm age. The proxy for quality is backed by Ivanov et al. (2011) who identify reputation of VCs as a critical success factor.

  3. Trust may also reduce the intensity of monitoring as the former represents a substitute for the latter (Duffner et al. 2009).

  4. See Bushman and Smith (2001) for a review on accounting information and corporate governance.

  5. In Jeng and Wells (2000), the effect of accounting standards’ quality on VC financing is not in the predicted direction though.

  6. In the corporate context, Bushman and Smith (2001), p. 292f) argue that “financial accounting information in corporate governance mechanisms is one channel by which financial accounting information potentially enhances the investment decisions”.

  7. Less frequent evaluations curb the agent’s opportunism when selecting subsequent acts.

  8. If a group of individuals determines the VC decision other issues related to the experience of its members may arise like cognitive conflict or differences between presence and use of knowledge (Forbes and Milliken 1999).

  9. In addition to being able to better interpret identical evaluation, more experienced VCs cater for even better quality of accounting information than less experienced ones (Agrawal and Cooper (2010)).

  10. Hellmann and Puri (2002), for example, find that VC financing goes hand in hand with institutionalizing human resource management or with the adoption of stock option plans, and Mäkelä and Maula (2005) report effects on internationalization strategies. Moreover, in the process of VC financing, the accounting system of the funded firm itself develops, and this allows for more frequent monitoring of the investee once the portfolio firm matures (Mitchell et al. 1997). Arguably, all of these activities become more important in later stages, when uncertainty about the entrepreneur and the firm’s prospects are at least partially resolved (Hopp and Lukas 2012).

  11. Moreover, if the size of the round increases, the general likelihood of VCs to be collaborating increases correspondingly, in order to reduce the financial burden for the individual VC participating (Manigart et al. 2005). This implies that when the size of funding increases, more partners are generally involved. We thank an anonymous reviewer for pointing to this effect, and refer to it explicitly in our empirical section.

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Acknowledgments

The authors would like to thank Roberto Di Pietra (the editor), Günter Franke, Thomas Weber, Julia Hein, Oliver Fabel, and three anonymous reviewers for invaluable feedback on an earlier draft of this paper.

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Correspondence to Christian Hopp.

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Hopp, C., Lukas, C. Evaluation frequency and evaluator’s experience: the case of venture capital investment firms and monitoring intensity in stage financing. J Manag Gov 18, 649–674 (2014). https://doi.org/10.1007/s10997-012-9231-8

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