Jonathan D. Arthurs

The Boundaries and Limitations of Agency Theory and Stewardship Theory in the Venture Capitalist/Entrepreneur Relationship*

The dynamic ownership arrangements surrounding the venture capitalist–entrepreneur (VC–E) relationship inherent in new ventures make the examination of principals’ or venture capitalists’ (VCs) and agents’ (entrepreneurs) governance arrangements interesting to explore. This article examines the limitations of agency theory and then stewardship theory in explaining the behaviors of individuals in the VC–E relationship. Our analysis points out the potential problems inherent in each theorys explanatory ability as it relates to the VC–E relationship. Lastly, theoretical gaps in the VC–E relationship are discussed along with suggestions for new theory surrounding this important and intriguing relationship.

Firm-Specific Human Capital and Governance in IPO Firms: Addressing Agency and Resource Dependence Concerns

Entrepreneurs with firm–specific human capital represent both a potential source of competitive advantage and a threat to appropriate the rents that are ultimately generated by a new venture. This situation presents interesting agency and resource dependence challenges. While potential investors in these ventures will want assurances that their interests are protected, they will also want to ensure that these key entrepreneurs remain with the organization. Using agency theory and resource dependence theory, we examine the types of governance mechanisms that are implemented in firms going through an initial public offering comparing those ventures which indicate a dependence on these critical entrepreneurs versus those that do not. Our analysis reveals that ventures exhibiting dependence on key entrepreneurs are associated with higher insider and outsider ownership by the board, greater start–up experience by the board, greater use of contingent compensation, and greater use of involuntary departure agreements.

Principal Costs in Initial Public Offerings

The initial public offering (IPO) of a new ventures stock often results in significant changes to the firms ownership structure. Because firm owners (principals) often have heterogeneous interests, conflicts can arise among the principals. While governance mechanisms are often effective in limiting agency problems, we suggest that principals can also attempt to use governance mechanisms to their own advantage in IPO settings. Specifically, when principal–principal conflict exists, powerful principals may exert control via governance mechanisms to pursue their own interests in ways that create inefficiencies in the form of ‘principal costs’.

Looking Attractive until You Sell: Earnings Management, Lockup Expiration, and Venture Capitalists

Earnings management occurs when managerial discretion allows managers to influence reported earnings and thus mislead some investors about the underlying economic performance and quality of the firm. This study considers how potential investors may guard against earnings management by observing negative stock price reaction at the lockup expiration period of initial public offering (IPO) firms as a negative signal. Findings from a sample of 160 newly public firms show that earnings management behaviour is stronger in IPO firms backed by venture capitalists (VCs). Moreover, VC reputation negatively moderates this relationship such that IPO firms backed by reputable VCs are less likely to manage earnings, suggesting that reputable VCs serve an auditing function following an IPO. Overall, we provide insights into signalling theory by examining negative signals arising from the behaviour of multiple agents in an IPO firm.

INFORMATION DISCLOSURE AND IPO VALUATION: WHAT KINDS OF INFORMATION MATTER AND IS MORE INFORMATION ALWAYS BETTER?

Many financial theories emphasize the positive relationship between information disclosure and firm performance. However, disclosure of information can harm a firm if others make strategic use of the information. In this paper, we test the effect of information disclosure on performance. Using a sample of all firms which went through an IPO in the U.S. during the 2001-2003 period, we examine the relationship between different types of information including 1) the specificity of information, 2) the accuracy of information, and 3) the amount of time for information diffusion and the valuation of the IPO firm. We use OLS regression to predict IPO performance including 1) underpricing, 2) percent premium and 3) 3 year cumulative average adjusted returns. Also, we check for a potential curvilinear relationship between the level of information disclosure and IPO performance. We find a negative relationship between information disclosure and underprcing but a positive relationship with percent premium. The implications of these findings and several directions for future research are discussed as well.

Internal Sequential Innovations and Market Value

Research shows that innovations contribute to a firms performance such as market value. However, research is less specific concerning how innovations contribute to market value. Simplistic assumptions are often made such as additivity, which assumes that the bundle of innovations can be additively separated into individual innovations. We identify some important interrelationships among innovations by drawing upon evolutionary economics and focusing on how the underlying technological trajectories drive the evolution of innovations. We suggest that some innovations are internal sequential innovations, which share the genealogical linkage from the same underlying technological trajectory. We further suggest that internal sequential innovations contribute significantly to a firms market value from three dimensions - the depth, coverage, and learning dimensions. Specifically, we show that for public corporations in four innovation-intensive industries from 1980 to 1994, the depth and coverage contribute positively to the market value. In addition, the learning dimension, or how long the sequential relationships among innovations have existed, has an inverted-U relationship with the market value.