ROBUST FINANCIAL CONTRACTING AND THE ROLE OF VENTURE CAPITALISTS

We derive a role for inside investors. such as venture capitalists, in resolving various agency problems that arise in a multistage financia l contracting problem. Absent an inside investor, the choice of securi ties is unlikely to reveal all private information, and overinvestment may occur. An inside investor, however, always makes optimal investme nt decisions if and only if he holds a fixed-fraction contract, where he always receives a fixed fraction of the project's payoff and financ es that same fraction of future investments. This contract also elimin ates any incentives of the venture capitalist to misprice securities i ssued in later financing rounds.