Academic journal article South Asian Journal of Management

Information Asymmetry Risks in Venture Capital Investments: Strategies of Transnational Venture Capital Firms in India [Dagger]

Academic journal article South Asian Journal of Management

Information Asymmetry Risks in Venture Capital Investments: Strategies of Transnational Venture Capital Firms in India [Dagger]

Article excerpt

Venture Capitalists (VCs) are niche financial intermediaries known to possess the forte in selecting and monitoring projects with an extreme level of information asymmetry. In the absence of tangible historical data on an investee firm, VC firms often base their risk estimates on tacit signals. While information asymmetry risks are the main stay of VC funded projects in general; those funded by transnational VC firms in destinations different from their countries of origin are even more risky owing to the geographical distance and cultural dissimilarities. The aim of this paper is to conceptualize, empirically investigate and statistically ascertain the relevant set of signals that matter to the transnational VC firms in India. To start with, we analyze the most pertinent signals such as the investee venture's funding-stage, syndication, domain specialization and the past start-up experience of the prospective founding team. Furthermore, we investigate the specific set of signals that are relevant in the Indian economic, political and socio-cultural milieu.

Key Words: Foreign VCs, India, Information Asymmetry, Signals, Transnational, Venture Capital (VC)


Venture Capitalists (VC firms) are financial intermediaries focused on funding projects in emerging high-technology realms. Nascent technologies, domains and business models and most importantly intangibility of assets are the mainstay of such VC funded projects. This results in an extreme level of information asymmetry and thus, funding these projects warrants specialized risk assessment skills. In fact, VC firms are known to possess the fo rte in selecting and monitoring ventures with an extreme level of information asymmetry (Chan, 1983; Sahlman, 1990; Macintosh, 1994; Amit, Glosten and Muller, 1990, 1993, 1998).

Information asymmetry results in two distinct kinds of risks-adverse selection and moral hazard. Adverse Selection risks are those resulting from hidden information (i.e., entrepreneurs possess certain information not known to the VCs). Moral Hazard risks are the ones emanating from hidden actions (i.e. entrepreneurs can take certain actions not observable by the VCs). As niche financial intermediaries, VC firms are known to be well-versed with strategies to tackle both of these. While Adverse selection is tackled by intensive proposal screening and due diligence, syndication of deals (coinvesting with other VC firms) and specialization (by domain, funding size, stage of funding); moral hazard is overcome by staging of investments, legal contracting and extensive monitoring of the investee firms (Gupta and Sapienza, 1992; Rosenstein, Bruno, Bygrave and Taylor, 1993; Barry, 1994; Lerner, 1994; Fried and Hisrich, 1994; Gompers and Lerner, 2004; and Pruthi, Wright and Lockett, 2003). In general, presence of information asymmetry warrants an extensive usage of signaling mechanisms to overcome the ensuing risks.

Whereas the VC funded projects are extremely risky in general, those funded by transnational VC firms operating in emerging economies are known to be even more precarious. Based on ownership type; the VC firms can be divided into two types- domestic and transnational. Domestic VC firms are the ones where the country of origin and the destination for investment are one and the same. Usually, these are either independent VC entities or off-shoots of other domestic financial intermediaries or corporate houses. The transnational VC firms on the other hand are multinational VC entities for whom, the countries of origin and the investment destinations are distinctly different. The global VC firms that scour the economies worldwide in search of investment opportu n ities fall in this category. Typically, the domestic and transnational VC firms are known to possess different set of skillsets. While the former are very well-connected with the local entrepreneurial and VC networks the latter possess the expertise and scale required to expand into foreign markets (Devigne et al. …

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