[We use an important legal event to examine the effect of managerial fiduciary duties on equity-debt conflicts. A 1991 legal ruling changed corporate directors' fiduciary duties in Delaware firms, limiting managers' incentives to take actions that favor equity over debt for distressed firms. After this, affected firms responded by increasing equity issues and investment and by reducing risk. The ruling was also followed by an increase in leverage, reduced reliance on covenants, and higher values. Fiduciary duties appear to affect equitybondholder conflicts in a way that is economically important, has impact on ex ante capital structure choices, and affects welfare.]

We compare the characteristics of real-world financial contracts to their counterparts in financial contracting theory. We do so by studying the actual contracts between venture capitalists (VCs) and entrepreneurs. The distinguishing characteristic of VC financings is that they allow VCs to separately allocate cash flow rights, board rights, voting rights, liquidation rights, and other control rights. We describe and measure these rights. We then interpret our results in relation to existing financial contracting theories. We also describe the interrelation and the evolution across financing rounds of the different rights.

I develop and estimate a model of cash auction bankruptcy using data on 205 Swedish firms. The results challenge arguments that cash auctions, as compared to reorganizations, are immune to conflicts of interest between claimholders but lead to inefficient liquidations. I show that a sale of the assets back to incumbent management is a common bankruptcy outcome. Sale‐backs are more likely when they favor the bank at the expense of other creditors. On the other hand, inefficient liquidations are frequently avoided through sale‐backs when markets are illiquid, that is, when industry indebtedness is high and the firm has few nonspecific assets.

Private equity funds are important to the economy, yet there is little analysis explaining their financial structure. In our model the financial structure minimizes agency conflicts between fund managers and investors. Relative to financing each deal separately, raising a fund where the manager receives a fraction of aggregate excess returns reduces incentives to make bad investments. Efficiency is further improved by requiring funds to also use deal-by-deal debt financing, which becomes unavailable in states where internal discipline fails. Private equity investment becomes highly sensitive to aggregate credit conditions and investments in bad states outperform investments in good states.

We analyze venture capital (VC) investments in twenty-three non-US countries and compare them to US VC investments. We describe how the contracts allocate cash flow, board, liquidation, and other control rights. In univariate analyses, contracts differ across legal regimes. However, more experienced VCs implement US style contracts regardless of legal regime. In most specifications, legal regime becomes insignificant controlling for VC experience. VC firms that do not use US style contracts fail significantly more often, even controlling for VC experience. The results are consistent with US style contracts being efficient across a wide range of legal regimes.

Theoretical work on the principal-agent problem in financial contracting focuses on the conflicts of interest between an agent / entrepreneur with a venture that needs financing, and a principal / investor providing funds for the venture. Theory has identified three primary ways that the investor / principal can mitigate these conflicts - structuring financial contracts, pre-investment screening, and post-investment monitoring and advising. In this paper, we describe recent empirical work and its relation to theory for one prominent class of principals venture capitalists (VCs). The empirical studies indicate that VCs attempt to mitigate principal-agent conflicts in the three ways suggested by theory. The evidence also shows that contracting, screening, and monitoring are closely interrelated. In screening, the VCs identify areas where they can add value through monitoring and support. In contracting, the VCs allocate rights in order to facilitate monitoring and minimize the impact of identified risks. Also, the equity allocated to VCs provides incentives to engage in costly support activities that increase upside values, rather than just minimizing potential losses. There is room for future empirical research to study these activities in greater detail for VCs, for other intermediaries such as banks, and within firms.

ABSTRACT We study the investment analyses of 67 portfolio investments by 11 venture capital (VC) firms. VCs describe the strengths and risks of the investments as well as expected postinvestment actions. We classify the risks into three categories and relate them to the allocation of cash flow rights, contingencies, control rights, and liquidation rights between VCs and entrepreneurs. The risk results suggest that agency and hold‐up problems are important to contract design and monitoring, but that risk sharing is not. Greater VC control is associated with increased management intervention, while greater VC equity incentives are associated with increased value‐added support.

We use an important legal event to examine the effect of managerial fiduciary duties on equity-debt conflicts. A 1991 legal ruling changed corporate directors' fiduciary duties in Delaware firms, limiting managers' incentives to take actions that favor equity over debt for distressed firms. After this, affected firms responded by increasing equity issues and investment and by reducing risk. The ruling was also followed by an increase in leverage, reduced reliance on covenants, and higher values. Fiduciary duties appear to affect equity-bondholder conflicts in a way that is economically important, has impact on ex ante capital structure choices, and affects welfare. The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

Abstract We examine the role private equity (PE) sponsors play in the resolution of financial distress of portfolio companies. PE-backed firms have higher leverage and default at higher rates than other companies borrowing in leveraged loan markets. But, PE-backed firms restructure more quickly, avoid bankruptcy court more often, and liquidate less often compared to other highly leveraged firms experiencing financial distress. PE owners are also more likely to retain control post-restructuring, often by infusing capital as firms approach distress. While default frequencies are higher among PE-backed firms, PE investors appear to manage financial distress at lower cost compared to other owners. (JEL G23, G32, G33)

ABSTRACT We study how firm characteristics evolve from early business plan to initial public offering (IPO) to public company for 50 venture capital (VC)‐financed companies. Firm business lines remain remarkably stable while management turnover is substantial. Management turnover is positively related to alienable asset formation. We obtain similar results using all 2004 IPOs, suggesting that our main results are not specific to VC‐backed firms or the time period. The results suggest that, at the margin, investors in start‐ups should place more weight on the business (“the horse”) than on the management team (“the jockey”). The results also inform theories of the firm.