Bargaining power and project risk in Venture Capital investments

This paper examines the link between Venture Capitalist competition and investment risk as a possible explanation of the differences in the Venture Capital activity among countries. In a double-sided moral hazard framework we model the effect of bargaining between risk neutral Venture Capitalists and risk averse entrepreneurs on the risk profile of the investees. The entrepreneurs’ bargaining power is assumed to be directly determined by the number of Venture Capitalist financiers in the market and the implicit competition among them. We show that as the entrepreneurs’ bargaining power increases, they enjoy higher rents which allow the Venture Capitalists to finance risky projects that they would otherwise avoid. The theoretical findings are then tested empirically using a European dataset of 22 countries for 2007-2012 where we find a positive effect of the number of investors on the magnitude of risky early stage Venture Capital investments.