VENTURE CAPITAL AND THE STRUCTURE OF CAPITAL-MARKETS - BANKS VERSUS STOCK MARKETS

The United States has many banks that are small relative to large corp orations and play a limited role in corporate governance, and a well d eveloped stock market with an associated market for corporate control. In contrast, Japanese and German banks are fewer in number but larger in relative size and are said to play a central governance role. Neit her country has an active market for corporate control. We extend the debate on the relative efficiency of bank-and stock market-centered ca pital markets by developing a further systematic difference between th e two systems: the greater vitality of venture capital in stock market -centered systems. Understanding the link between the stock market and the venture capital market requires understanding the contractual arr angements between entrepreneurs and venture capital providers; especia lly, the importance of the opportunity to enter into an implicit contr act over control, which gives a successful entrepreneur the option to reacquire control from the venture capitalist by using an initial publ ic offering as the means by which the venture capitalist exits from a portfolio investment. We also extend the literature on venture capital contracting by offering an explanation for two central characteristic s of the U.S. venture capital market: relatively rapid exit by venture capital providers from investments in portfolio companies; and the co mmon practice of exit through an initial public offering. (C) 1998 Els evier Science S.A. All rights reserved.