In this paper I analyze two types of financial intermediaries that finance entrepreneurial firms: Banks and Venture Capital firms. The core of this work is a new mathematical model that explains why Venture Capital firms focus on financing high-risk firms with high growth potential in knowledge-intensive, high-tech industries. And why Banks, on the other hand, tend to be more conservative and focus exclusively on low-risk, stable, more mature firms. In my model an endowed financial intermediary has a choice to structure either as a Bank or a Venture Capital firm. The advantage of structuring as a Bank is the higher monitoring effort the intermediary will exert when monitoring her investment portfolio. This benefit comes from the fact that Banks are financed by short-term demand deposits and are prone to bank runs if their claim holders observe a deteriorating performance. The advantage of structuring as a VC is the fact that this type of intermediary is not subject to bank runs because it is financed by long-term depositors. This long-term financial structure leads to lower monitoring effort on part of the Venture Capital firm, but the risk of inefficient liquidation is nonexistent. This trade-off drives the intermediary’s choice. The results of my work state that intermediaries presented with low-risk investment projects will structure as Banks and intermediaries presented with high-risk ones will structure as Venture Capital firms. At high levels of risk the benefit of increased monitoring effort is simply overshadowed by the increased chance of inefficient liquidation.
|Educations||MSc in Advanced Economics and Finance, (Graduate Programme) Final Thesis|
|Number of pages||39|