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"Monitoring and Evaluation by Financiers"

Dan Bernhardt and Vladimir Dvoracek


First Author :

Dan Bernhardt
University of Illinois at Urbana-Champaign
1206 S. Sixth Street, M/C 706
Champaign, IL 61820

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Second Author :

Vladimir Dvoracek
Business Administration
University College of the Fraser Valley
33844 King Road, Office B336
V2S 7M8
Abbotsford, BC

Abstract :
This paper considers a financier contemplating a venture capital investment in a firm whose true value is unknown. The financier must make information- gathering and investment decisions on an ongoing basis to decide whether to undertake the investment and, later, if he chooses to finance the firm, how to manage his investment. We characterize how the financierís information acquisition is affected by the liquidity of the market for his claims to the firm, and derive the implications for the pricing of the firm. We distinguish between two qualitatively different types of information acquisition: evaluation efforts made prior to a potential investment; and monitoring efforts of already-funded firms that impact upon the financierís decisions about whether to take an active position in the firm (e.g. replace management) and whether to change its financial stake. We investigate the effects of liquidity on share price, describing why the market responds more favorably to less liquid forms of finance, and explore the consequences for investor activism. Finally, we characterize the socially optimal levels of evaluation and monitoring in order to determine when a marginal increase in liquidity has welfare-enhancing effects on the financierís behavior.
Manuscript Received : 2000
Manuscript Published : 2000
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