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Do Founders Control Start-Up Firms that Go Public?


Abstract: Black & Gilson (1998) argued that an IPO-welcoming stock market stimulates venture deals by enabling VCs to give founders a valuable “call option on control”. We study 18,000 startups to investigate the value of this option. Among firms that IPO, 60% of founders are no longer CEO. With little voting power, only half of the others survive three years as CEO. At initial VC financing, the probability of getting real control of a public firm for three years is 0.4%. Our results shed light on control evolution in startups, and cast doubt on the plausibility of the call-option theory linking stock and VC markets.
Topics: Initial public offering (54%), Venture capital (53%), Call option (51%), Stock market (51%)

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Articles by Maurer Faculty Faculty Scholarship
2020
Do Founders Control Start-up Firms that Go Public? Do Founders Control Start-up Firms that Go Public?
Brian Broughman
Indiana University Maurer School of Law
, bbroughm@indiana.edu
Jesse M. Fried
Harvard University Law School
Follow this and additional works at: https://www.repository.law.indiana.edu/facpub
Part of the Securities Law Commons
Recommended Citation Recommended Citation
Broughman, Brian and Fried, Jesse M., "Do Founders Control Start-up Firms that Go Public?" (2020).
Articles by Maurer Faculty
. 2885.
https://www.repository.law.indiana.edu/facpub/2885
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contact rvaughan@indiana.edu.

DO
FOUNDERS
CONTROL
START-UP
FIRMS
THAT
GO
PUBLIC?
BRIAN
BROUGHMAN*
&
JESSE
M.
FRIED**
Black
&
Gilson
(1998)
argue
that
an
IPO-welcoming
stock
market
stimu-
lates
venture
deals
by
enabling
VCs
to
give
founders
a
valuable
"call
option
on
control."
We
study
18,000
startups
to
investigate
the
value
of
this
option.
Among
firms
that
reach
IPO,
60%
of
founders
are
no
longer
CEO.
With
little
voting
power,
only
half of
the
others
survive
three
years
as
CEO.
At
initial
VC
financ-
ing,
the
probability
of
getting
real
control
of
a
public
firm
for
three
years
is
0.4%.
Our
results
shed
light
on
control
evolution
in
startups,
and
cast
doubt
on
the
plausibility
of
the
call-option
theory
linking
stock
and
VC
markets.
INTRODUCTION
..................................................
50
I.
VENTURE
CAPITAL
AND
STOCK
MARKETS
..................
53
A.
The
Observed
Link
between
Venture
Capital
and
Stock
Markets.............
........
B.
The
Control-Reacquisition
Theory
......................
54
II.
DATABASE
OF
VC-BACKED
FIRMS
.........................
57
A.
Constructing
a
Sample
of
VC-Backed
Firms
............
57
B.
Description
of
Sample
Firms
..........................
59
III.
Do
FOUNDERS
BECOME
(AND
REMAIN)
CEO
OF A
PUBLIC
COMPANY?
.
. . . .
.
. . . . .
. . . . . .
. . . . . . .
. . . . . .
. . . . . .
. . . . . . .
. . . . .
65
A.
Founder-CEO
at
IPO?
...............................
66
B.
Founder-CEO
after
IPO?
............................
69
IV.
Do
FOUNDER-CEOs
HAVE
(AND
KEEP)
SUBSTANTIAL
VOTING
POWER?
. . . . .
. . . . . .
. . . . . .
. . . . . . .
. . . . . .
. . . . . .
. . . . .
. . . . . .
. .
71
A.
Founder
Voting
Power
at
and
after
IPO
................
72
B.
Founder-CEO/Blockholder
at
and
after
IPO
............
73
V.
Ex
ANTE
LIKELIHOOD
OF
CONTROL
REACQUISITION
VIA
IPO
.........
76
A.
Founder-CEO
......................................
76
B.
Founder-CEO/Blockholder
...........................
79
VI.
VC
RETURNS
AND
FOUNDER
CONTROL
IN
IPO
FIRMS
.......
....
79
VII.
WHAT
CAN
THE
DATA
TELL
US?
..........................
84
CONCLUSION..
......................................
...........
86
*
Indiana
University
Maurer
School
of
Law.
**
Harvard
Law
School.
For
comments
and
in
some
cases
data
assistance,
we
thank
Arevik
Avedian,
Bobby
Bartlett,
Lucian
Bebchuk,
David
Berger,
John
Coates,
Luca
Enriques,
Yehonatan
Givati,
Assaf
Hamdani,
Sharon
Hannes,
Scott
Hirst,
Irena
Hutton,
Howell
Jackson,
Ehud
Kamar,
David
Kershaw,
Reinier
Kraakman,
Barak
Medina,
Nate
Nicholas,
Elizabeth
Pollman,
Mark
Roe, Holger
Spamann,
Guhan
Subramanian,
Doron
Teichman,
Yishay
Yaffe,
and
participants
at
the
ABA
Business
Law
Conference,
the
Conference
on
Empirical
Legal
Studies,
the
Goethe/Penn
Conference
on
Law
and
Finance,
the
HLS
Law
and
Economics
Sem-
inar,
the
HLS
Corporate-Law
Workshop,
Hebrew
University,
IDC
Herzliya,
Vanderbilt,
and
Indiana
University.
For
research
assistance,
we
thank
Clayton
Hackney,
Justin
Kenney,
Tyler
Kohring,
Jacob
Laband,
Sam
Learner,
Jean
Lee,
Richard
Liu,
Robert
Mahari,
Asher
Perez,
and
Lauren
Semrau.

Harvard
Business
Law
Review
INTRODUCTION
Startup
founders,
who
typically must
cede
control
of
their
firms
to
ob-
tain VC'
financing,
are
widely
believed
to
regain
control
in
the
event
of
an
initial public offering
(IPO). This view
is
reinforced
by
the media
salience
of
prominent
founders
such
as
Facebook's
Mark Zuckerberg,
Google's
Sergey
Brin
and
Larry
Page,
and
Snap's
Evan
Spiegel.
Travis
Kalanick's
loss
of
the
CEO
position
before
Uber's
IPO
seems
to
be
the
exception
that
proves
the
rule.
2
Indeed,
the
possibility
of
founder
control-reacquisition
via
IPO
under-
lies
an
influential
theory
for
why
VC
requires
a
robust
stock market.
3
On
this
theory,
an
IPO-welcoming
stock
market
makes
possible
a
VC
exit
that
can
return
control
to
founders,
enabling
VCs
to
implicitly
give
founders
a
valua-
ble
"call option
on
control"
that
they
can
exercise
if
successful.
VCs'
ability
to
offer
this
call
option,
this
theory
claims,
makes
VC
financing
more
ac-
ceptable
to
control-loving
founders
and
can
thereby
spur
more founder-VC
"deals."1
But
we
know
little
about
the
likelihood
of
founder-control
return
via
IPO,
and
the
extent
and
duration
of
any
such
control.
In
short,
we
know
little
about
the
ex
ante
value
of
this
call option
on
control
at
the
time
when
foun-
ders
agree
to
accept
VC
financing.
Prior
work
has,
in
passing,
reported
the
frequency
of
founders
being
CEO
at
IPO.
5
But
the samples
are
small,
non-
random,
and
old.
And
because
these studies
had
a
different
focus,
they
did
not
consider
the
voting
power
of
founder-CEOs
at
IPO,
the
extent
and
dura-
tion
of
founders'
control
post-IPO,
or
the ex
ante
likelihood
of
founder-con-
trol
return
via
IPO.
We
investigate
the
ex
ante
value
of
founders'
call
option
on
control via
IPO
by
collecting
a
sample
of
over
18,000
startups
receiving
first-round
VC
funding
during
1990-2012
("financing
vintages"
1990-2012),
and
then
in-
vestigating,
within
a
random subsample
of
these
firms
that
conduct
an
IPO,
two
measures
of
founder
control: serving
as CEO
and
voting
power.
For
each
firm,
we
measure
founder
control
at three
points:
upon
completion
of
'
We use
the
abbreviation
"VC" to
denote
"venture
capitalist,"
"venture capital,"
or
"venture-capital
fund."
2
For
Travis
Kalanick's
(forced)
resignation
from
his
position
as
CEO
of
Uber,
see
Greg
Bensinger,
Uber
CEO
Travis
Kalanick
Quits
as
Investors
Revolt,
WALL
ST.
J.
(June
21,
2017),
https://www.wsj.com/articles/uber-ceo-travis-kalanick-resigns-1498023559.
3See
Bernard
S.
Black
&
Ronald
J.
Gilson,
Venture
Capital
and
the
Structure
of
Capital
Markets:
Banks
versus
Stock
Markets,
47
J.
FIN.
EcON.
243,
243
(1998)
[hereinafter
Black
&
Gilson
(1998)].
According
to SCOPUS
(May
2018),
Black
&
Gilson
(1998)
is
in the
top
5%
of
JFE
papers
based
on
citation
count.
4
See
Section
2.
5
See,
e.g.,
Malcolm
Baker
&
Paul
A.
Gompers,
The
Determinants
of
Board
Structure
at
the
Initial
Public
Offering,
46
J.
L.
&
ECON.
569,
589
(2003);
Steven
N.
Kaplan
et
al.,
Bet
on
the
Jockey
or
the
Horse?
Evidence
from
the
Evolution
of
Firms
from
Early
Business
Plans
to
Public
Companies,
64
J.
FiN.
75,
96
(2009).
50
[Vol.
10

2020]
Do
Founders
Control
Start-Up
Firms
That
Go
Public?
IPO
("at
IPO"),
one
year
after
IPO
("IPO
+1"),
and
three
years
after
lIPO
("IPO+3").
We
start
by
measuring
the
frequency
of
founder-control
reacquisition
via
IPO
ex
post,
that
is,
conditional
on
IPO.
A
founder
is
considered
to
have
"weak"
control
if
she
is
CEO
("founder-CEO")
and
"strong"
control
if
she
is
CEO
and,
along
with
cofounders,
has
a
voting
interest
of
at
least
30%
("founder-CEO/blockholder").
At
IIPO,
most
founders
lack
even
weak
con-
trol:
the
frequency
of
founder-CEO
is
only
41%.
Even
fewer
have
strong
control.
At IPO,
the
frequency
of
founder-CEO/blockholder
is
about
7%.
Moreover,
for
either
type
of
control,
founders'
control
generally
is
not
"du-
rable"
(lasting
at
least
three
years).
By
IiPO+3,
the
frequency
of
founder-
CEO
drops
from
41%
to
21%,
and
the
frequency
of
founder-CEO/
blockholder
drops
from
about
7%
to
2.5%.
Even
if
a
startup
is
successful
enough
to
reach
IPO,
a
founder
is
unlikely
to
regain
durable
control.
We
then
use
the
11,104
firms
in
financing
vintages
1990-2002
to
inves-
tigate
the
ex
ante
likelihood
of
founders
exercising
the
call
option
on
control.
We
find
that,
as
of
initial
VC
financing,
the
likelihood
is
extremely
remote.
The
main
reason:
most
VC-backed
firms-including
many
of
the
most
suc-
cessful-exit
not
via
IPO
but rather
via
sale
to
a
buyer
(an
"M&A
exit").
In
these
financing
vintages,
only
about
6%
of
founders
take
their
firms
to
IPO
as
CEO,
and
1%
take
their
firms
to
IPO
as
CEO/blockholder.
Because
of
the
high
frequency
of
post-IPO
control
attrition,
the
ex
ante
likelihood
of
ob-
taining
durable
control
is
even
lower
(3%
for
founder-CEO
and
0.4%
for
founder-CEO/blockholder).
We
also
investigate
whether
control
return
via
IPO
is
a
carrot
to
reward
the
most
successful
founders-those
generating
the
highest
returns
for
VCs.
Since
IPO
exits
are
on
average
more
profitable
for
VCs
than
M&A
exits,
and
only
an
IPO
can
return
founder-control,
founders
reacquiring
control
via
IPO
likely
generate
above-average
returns
for
VCs.
But
the
"carrot"
hypoth-
esis
might
also
be
expected
to
apply
within
IPO
exits:
founders
of
IPO
firms
should
be
more
likely
to
retain
control
as
IPO
profitability
for
VCs
in-
creases.
Yet,
we find
no
evidence
that
VC
returns
are
positively
correlated
with
control
reacquisition.
Indeed,
we
find
the
opposite
in
some
models;
higher
VC
returns
are
associated
with
a
lower
frequency
of
founder
control.
Our
paper
contributes
to
the
literature
on
founder
exit
from
the
CEO
position
in
VC-backed
startups.
Most
prior
work
focuses
on
firms
where
VCs
exit
via
M&A
6
or
have
not
yet
exited.
7
This
work
finds
that
founders
6
See,
e.g.,
Brian
Broughman
&
Jesse
M.
Fried,
Carrots
and
Sticks:
How
VCs
Induce
Entrepreneurial
Teams
to
Sell
Startups,
98
CORNELL.
L.
REV.
1319,
1323-1325
(2013)
[herein-
after
Broughman
&
Fried
(2013)].
'
See
NoAM
WASSERMAN,
THE
FOUNDER'S
DILEMMAS:
ANTICIPATING
ANI)
AVOIDING
THE
PITFALLs
THAT
CAN
SINK
A
STARTUP
11-16
(2012)
[hereinafter
FOUNDER'S
DILEMMAS];
An-
namaria
Conti
&
Stuart
J.
H.
Graham,
Valuable
Choices:
Prominent
Venture
Capitalists'
Influ-
ence
on
Startup
CEO
Replacements,
MGMT.
Sa.,
2,
2-3
(2019);
Thomas
Hellmann
&
Manju
Puri,
Venture
Capital
and
the
Professionalization
of
Start-up
Firms:
Empirical
Evidence,
57
J.
FIN.
169,
195
(2002);
Noam
Wasserman,
Founder-CEO
Succession
and
the
Paradox
of
En-
51

Harvard
Business
Law
Review
often
exit
the
CEO
position,'
many
times
involuntarily.
9
Work
by
Baker
and
GompersIO
and
by
Kaplan,
Sensoy
and
Strdmberg"
reports
the
frequency
of
founder-CEO
at
IPO only
in
passing,
as
their
focus
is
not
the
arc
of
founder
control.
12
Our
work
is
the
first
to
systematically
examine
founders'
propen-
sity
to
remain
CEO
in
VC-backed
firms
that
are
successful
enough
to
go
public.
Our
results
suggest that
this propensity
is
surprisingly
low.
Our
paper
is
also
the
first
to
systematically measure
founder
voting
power
at
and
after
IPO,
which
is
important
for
understanding
how
control
of
VC-backed
firms
evolves over
time.
Our
paper
sheds
light
on
the
plausibility
of
Black
&
Gilson
(1998)'s
"call
option
on
control"
theory
linking
VC
and
stock
markets.
We
show
that
the
ex
ante
likelihood
of
founders reacquiring
control
via
IPO
is
extremely
low,
especially
when
we
focus
on
control
that
is
both strong
(founders
have
enough
voting
power
to
ensure
they
remain
in
the saddle) and
durable
(con-
trol
lasts
at
least
three
years).
Our
findings
call
into question the
claim
that
founders
deciding
whether
to
accept
VC
financing
weigh
heavily
the
ex
ante
value
of
their
call
option on
control
via
IPO.
Our
results
therefore
suggest
that
an
active
IPO
market
might
not
be
as
important
for
sustaining
a
venture
ecosystem
as
is
generally
believed.
The
remainder
of
this
paper
proceeds
as
follows.
Part
I
provides
the
motivation
for
our
study.
Part
II
describes
our
data.
Part
m
reports the
fre-
quency
of
founder-CEO
at
and
after
IPO.
Part
IV
describes
the
frequency
of
founder-CEO/blockholder
at and
after
IPO.
Part
V
briefly
describes
the
ex
ante
probability
(as
of
initial
VC
financing)
that
a
firm
will
have
an
IPO
exit
with
a
founder-CEO
or
founder-CEO/blockholder.
Part
VI
examines
the
re-
lationship
between
VC
returns
and
founder
control
among IPO
firms.
Part
VII
discusses
limitations
of
our
analysis.
trepreneurial
Success,
14
ORG.
SC.
149,
162-165
(2003).
For
a
notable
recent exception,
see
Michael
Ewens
&
Matt Marx,
Founder
Replacement
and
Startup
Performance,
31
REv.
FIN.
STUD.
1533,
1563-1564
(2018).
They
investigate
the
rate
and
effect
of
replacing
founders
using
a
large
sample
of
VC-backed
startups
founded
between
1995
and 2008,
some
of
which
reach
IPO.
But their
study does
not
distinguish
between
founders
serving
as
CEOs
and
foun-
ders
serving
in
other
executive roles,
or
between startups
that
reach
IPO
and those
with
suc-
cessful
M&A
exits,
as
its
focus
is
not
on
measuring
founder-control
reacquisition
via
IPO.
'See,
e.g.,
Broughman
&
Fried
(2013),
supra
note
6,
at
1323-1325;
Brian
Broughman,
Investor
Opportunism
and
Governance
in
Venture
Capital,
in
VENTURE
CAPITAL:
INVESTMENT
STRATEGIES,
STRUCTURES
AND
Poicies
355-357
(Douglas Cumming
ed.,
2010).
*
See,
e.g.,
FOUNDER
S
DILEMMAS,
supra
note
7,
at
16
(2012).
10
See
Baker
&
Gompers,
supra
note
5,
at
589
(examining
several
hundred
VC-backed
IPOs
during
1978-1987).
"
See
Kaplan
et
al.,
supra
note
5,
at
96
(examining
a
small,
non-random
sample
of
IPOs
in
2004).
12
See
also
Bharat
A.
Jain
&
Filiz
Tabak,
Factors
Influencing
the
Choice
between
Founder
versus
Non-Founder
CEOs
for
IPO
Firms,
23
J.
Bus.
VENTURING
21,
41-42
(2008)
(reporting
founder-CEO
at
IPO
in
several
hundred
VC-backed
IPOs
in
1997);
Timothy
G.
Pollock
et
al.,
Dance
with
the
One
that
Brought
You?
Venture
Capital
Firms
and
the
Retention
of
Founder-
CEOs,
3
STRATEGIC
ENTREPRENEURSHIP
J.
199,
211-212
(2009)
(reporting
founder-CEO
at
IPO
in
about
190
VC-backed firms
during
1995-2000).
52
[Vol.
10

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Darian M. Ibrahim1Institutions (1)
Abstract: Silicon Valley's success has led other regions to attempt their own high-tech transformations, yet most imitators have failed. Entrepreneurs may be in short supply in these "non-tech" regions, but some non-tech regions are home to high-quality entrepreneurs who relocate to Silicon Valley due to a lack of local financing for their start-ups. Non-tech regions must provide local finance to prevent entrepreneurial relocation and reap spillover benefits for their communities. This Article compares three possible sources of entrepreneurial finance - private venture capital, state-sponsored venture capital, and angel investor groups - and finds that angel groups have distinct advantages when it comes to funding innovation in non-tech regions. This entrepreneurial finance story is then supplemented by a "law and entrepreneurship" story - specifically, a look at securities laws that might impede optimal levels of angel group financing.

14 citations


Journal ArticleDOI
Paul Mason1, Steven Utke2Institutions (2)
Abstract: Private equity and venture capital funds (“private funds”) are an increasingly important component of the economy and hold substantial ownership in other private firms. These funds have unique legal organizational structures, which academic literature has not yet accounted for. This paper has three main goals. First, we lay out the basic legal structure of private funds and describe how these funds interact with the firms they own (“portfolio companies”). Second, we explain the implications of this structure for recent finance research, focusing on how funds’ structure affects secondary market pricing of funds. Third, we discuss how both private fund and private firm structure affects accounting and economics research on private firms. Because a large number of private firms are now owned by private funds, falling under the funds’ unique organizational structure, we urge caution in drawing conclusions regarding private firms when researchers are unable to clearly distinguish between stand-alone private firms and those private firms owned and controlled by private funds (or other parent entities). We also specifically discuss the use of tax return data to study private firms; under the current laws of the U.S., these data are unlikely to allow researchers to isolate stand-alone firms, making these data unreliable for evaluating certain private firm attributes in economics, as well as private firm financial reporting choices in accounting.

11 citations


Posted Content
Casimiro Antonio Nigro1, Jörg Stahl2Institutions (2)
Abstract: This paper investigates the implications of the fair value protections contemplated by the standard corporate contract (i.e., the standard contract form for which corporate law provides) for the entrepreneur–venture capitalist relationship, focusing, in particular, on unavoidable value-destroying trade sales. First, it demonstrates that the typical entrepreneur–venture capitalist contract does institutionalize the venture capitalist’s liquidity needs, allowing, under some circumstances, for counterintuitive instances of contractually-compliant value destruction. Unavoidable value-destroying trade sales are the most tangible example. Next, it argues that fair value protections can prevent the entrepreneur and venture capitalist from allocating the value that these transactions generate as they would want. Then, it shows that the reality of venture capital-backed firms calls for a process of adaptation of the standard corporate contract that has one major step in the deactivation or re-shaping of fair value protections. Finally, it argues that a standard corporate contract aiming to promote social welfare through venture capital should feature flexible fair value protections.

9 citations


Cites background or result from "Do Founders Control Start-Up Firms ..."

  • ...For instance, only venture capitalists who enjoy residual control over the firm will be able to steer decision-making at both the board and the shareholder levels and will thus be able to consummate a trade sale in the form of an asset combination (i.e., a 79 On the free-riding dynamics that emerge in this context, see, e.g., Coates IV (2018), pp 584-586; or, equivalently, Saez Lacave and Gutierrez (2010), pp 433-434....

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  • ...Empirical evidence seems to be at odds, however, with the control re-acquisition theory: Broughman and Fried (2020) have shown, in fact, that by the time IPOs occur most entrepreneurs have already (forcedly or voluntarily) left the firm....

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  • ...See, e.g., Coates IV (2018), p 575....

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  • ...For a general discussion, see, e.g., Coates IV (2018), pp 577-578 and 588-590....

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  • ...81 On functional equivalence, see, Coates IV (2018), pp 572-573....

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ReportDOI
Dhruv Aggarwal1, Ofer Eldar2, Yael V. Hochberg3, Yael V. Hochberg4  +2 moreInstitutions (6)
Abstract: We create a novel dataset to examine the nature and determinants of dual-class IPOs. We document that dual-class firms have different types of controlling shareholders and wedges between voting and economic rights. We find that the founders' wedge is largest when founders have stronger bargaining power. The increase in founder wedge over time is due to increased willingness by venture capitalists to accommodate founder control and technological shocks that reduced firms' needs for external financing. Greater founder bargaining power is also associated with a lower likelihood of sunset provisions that eliminate dual-class structures within specified periods. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

7 citations


Journal ArticleDOI
Mark J. Roe1, Roy Shapira2Institutions (2)
Abstract: The notion of stock-market-driven short-termism relentlessly whittling away at the American economy’s foundations is widely accepted and highly salient. Presidential candidates state as much. Senators introduce bills assuming as much. Corporate interests argue as much to the Securities and Exchange Commission and the corporate law courts. Yet the academic evidence as to the problem’s severity is no more than mixed. What explains this gap between widespread belief and weak evidence? This Article explores the role of narrative power. Some ideas are better at being popular than others. The concept of pernicious stock market short-termism has three strong qualities that make its narrative power formidable: (1) connotation — the words themselves tell us what is good (reliable long-term commitment) and what is not (unreliable short-termism); (2) category confusion — disparate types of corporate misbehavior, such as environmental degradation and employee mistreatment, are mislabeled as being truly and primarily short-termism phenomena emanating from truncated corporate time horizons (when they in fact emanate from other misalignments), thereby making us view short-termism as even more rampant and pernicious than it is; and (3) confirmation — the idea is regularly repeated, because it is easy to communicate, and often boosted by powerful agenda-setters who benefit from its repetition. The Article then highlights the real-world implications of narrative power — powerful narratives can be more certain than the underlying evidence, thereby leading policymakers astray. For example, a favorite remedy for stock-market-driven short-termism is to insulate executives from stock market pressure. If lawmakers believe that short-termism is a primary cause of environmental degradation, anemic research and development, employee mistreatment, and financial crises — as many do — then they are likely to focus on further insulating corporate executives from stock-market accountability. Doing so may, however, do little to alleviate the underlying problems, which would be better handled by, say, stronger environmental regulation and more astute financial regulation. Powerful narratives can drive out good policymaking.

6 citations


References
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Journal ArticleDOI
Abstract: This paper examines the structure of staged venture capital investments when agency and monitoring costs exist. Expected agency costs increase as assets become less tangible, growth options increase, and asset specificity rises. Data from a random sample of 794 venture capital-backed firms support the predictions. Venture capitalists concentrate investments in early stage and high technology companies where informational asymmetries are highest. Decreases in industry ratios of tangible assets to total assets, higher market-to-book ratios, and greater R&D intensities lead to more frequent monitoring. Venture capitalists periodically gather information and maintain the option to discontinue funding projects with little probability of going public.

2,080 citations


"Do Founders Control Start-Up Firms ..." refers background in this paper

  • ...36 Consistent with Baker & Gompers (2003), their presence is associated with a lower probability of founder-CEO at IPO....

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  • ...16 Thus, VCs typically provide funding in stages as a means to obtain leverage between financing rounds (Gompers 1995); negotiate for preferred shares with substantial blocking rights (Kaplan & Stromberg 2003; Fried & Ganor 2006); and typically ensure that VCs and independent directors have enough board seats to replace the CEO (Broughman & Fried 2010; Broughman 2010)....

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  • ...Baker & Gompers (2003) report a rate of 57% for several hundred VC-backed IPOs during 1978-1987....

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  • ...Consistent with Baker & Gompers (2003), the frequency of founder-CEO at IPO is higher if duration to IPO is shorter and pre-IPO VC financing is lower [Table 3 - Panel B]....

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  • ...6 Baker & Gompers (2003) examines several hundred VC-backed IPOs during 1978-1987 and Kaplan et al. (2009) looks at more recent IPOs (in 2004), but the sample is small and non-random....

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Journal ArticleDOI
Thomas Hellmann1, Manju Puri2, Manju Puri3Institutions (3)
Abstract: This paper examines empirical evidence on the impact that venture capitalists can have on the development path of new firms. We use a hand-collected data set on Silicon Valley start-up companies that allows us to "look inside the black box" and analyze the influence of venture capital on the professionalization of firms' internal organization. The evidence suggests that there is a "soft" facet to venture capitalists, in terms of supporting companies to build up their human resources within the organization. Venture capital is also important at the top, in that venture capital backed companies are more likely and faster to bring in outsiders as CEOs. These CEO replacements are often accompanied with the founder departing from the company, suggesting that venture capitalists also exhibit a "hard" facet in terms of exercising control. The paper examines how these various roles are interrelated, and shows how the role of venture capital varies with the state of the company.

1,704 citations


"Do Founders Control Start-Up Firms ..." refers background in this paper

  • ...…work focuses on firms where VCs exit via M&A (Broughman & Fried 2013) or have not yet exited (Wasserman 2003; Wasserman 2012; Conti & Graham 2016; Hellmann & Puri 2002).5 This work finds that founders often exit the CEO position (e.g., Broughman & Fried 2013; Broughman 2010), many times…...

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01 Jan 1996
Abstract: We analyze incomplete long-term financial contracts between an entrepreneur with no initial wealth and a wealthy investor. Both agents have potentially conflicting objectives since the entrepreneur cares about both pecuniary and non-pecuniary returns from the project while the investor is only concerned about monetary returns. We address the questions of (i) whether and how the initial contract can be structured in such a way as to bring about a perfect coincidence of objectives between both agents (ii) when the initial contract cannot achieve this coincidence of objectives how should control rights be allocated to achieve efficiency? One of the main results of our analysis concerns the optimality properties of the (contingent) control allocation induced by standard debt financing.

1,589 citations


Journal ArticleDOI
Steven N. Kaplan1, Per Strömberg2Institutions (2)
Abstract: In this paper, we compare the characteristics of real world financial contracts to their counterparts in financial contracting theory. We do so by conducting a detailed study of actual contracts between venture capitalists (VCs) and entrepreneurs. We consider VCs to be the real world entities who most closely approximate the investors of theory. (1) The distinguishing characteristic of VC financings is that they allow VCs to separately allocate cash flow rights, voting rights, board rights, liquidation rights, and other control rights. We explicitly measure and report the allocation of these rights. (2) While convertible securities are used most frequently, VCs also implement a similar allocation of rights using combinations of multiple classes of common stock and straight preferred stock. (3) Cash flow rights, voting rights, control rights, and future financings are frequently contingent on observable measures of financial and non-financial performance. (4) If the company performs poorly, the VCs obtain full control. As company performance improves, the entrepreneur retains / obtains more control rights. If the company performs very well, the VCs retain their cash flow rights, but relinquish most of their control and liquidation rights. The entrepreneur's cash flow rights also increase with firm performance. (5) It is common for VCs to include non-compete and vesting provisions aimed at mitigating the potential hold-up problem between the entrepreneur and the investor. We interpret our results in relation to existing financial contracting theories. The contracts we observe are most consistent with the theoretical work of Aghion and Bolton (1992) and Dewatripont and Tirole (1994). They also are consistent with screening theories.

1,577 citations


"Do Founders Control Start-Up Firms ..." refers background in this paper

  • ...…in stages as a means to obtain leverage between financing rounds (Gompers 1995); negotiate for preferred shares with substantial blocking rights (Kaplan & Stromberg 2003; Fried & Ganor 2006); and typically ensure that VCs and independent directors have enough board seats to replace the CEO…...

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Journal ArticleDOI
Paul A. Gompers1, Josh Lerner1Institutions (1)
Abstract: V T enture capital has developed as an important intermediary in financial markets, providing capital to firms that might otherwise have difficulty attracting financing. These firms are typically small and young, plagued by high levels of uncertainty and large differences between what entrepreneurs and investors know. Moreover, these firms typically possess few tangible assets and operate in markets that change very rapidly. Venture capital organizations finance these high-risk, potentially high-reward projects, purchasing equity or equity-linked stakes while the firms are still privately held. The venture capital industry has developed a variety of mechanisms to overcome the problems that emerge at each stage of the investment process. At the same time, the venture capital process is also subject to various pathologies from time to time, which can create problems for investors or entrepreneurs. The primary focus of this article is on drawing together the empirical academic research on venture capital and highlighting what is still not known. With this focus in mind, four limitations should be acknowledged at the outset. First, this paper will not address the many theoretical papers that examine various aspects of the venture capital market, much of it examining the role that venture capitalists play in mitigating agency conflicts between entrepreneurial firms and outside investors.' Second, this article does not focus on the intricacies of the

1,453 citations


"Do Founders Control Start-Up Firms ..." refers background in this paper

  • ...A country’s robust legal protection of investors might cause both VC markets and stock 7 Gompers & Lerner 2001; Metrick & Yasuda 2010; Puri & Zarutskie 2012....

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