Working paper series / Institute for Monetary and Financial Stability
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This paper shows that investors financing a portfolio of projects may use the depth of their financial pockets to overcome entrepreneurial incentive problems. Competition for scarce informed capital at the refinancing stage strengthens investors’ bargaining positions. And yet, entrepreneurs’ incentives may be improved, because projects funded by investors with “shallow pockets” must have not only a positive net present value at the refinancing stage, but one that is higher than that of competing portfolio projects. Our paper may help to understand provisions used in venture capital finance that limit a fund’s initial capital and make it difficult to add more capital once the initial venture capital fund is raised.