07 Venture Capital and the Structure of Capital Ma

VenturecapitalandthestructureofcapitalmarketsBanksversusstockmarketsBernardS.Blacka&RonaldJ.Gilsonb1aColumbiaUniversitySchoolofLaw,NewYork,NY10027,USAbStanfordUniversitySchoolofLaw,Stanford,California94305,USAandColumbiaUniversitySchoolofLaw,NewYork,NY10027,USA(ReceivedJune1996;finalversionreceivedNovember1997)_____________________________________________________________________________AbstractTheUnitedStateshasmanybanksthataresmallrelativetolargecorporationsandplayalimitedroleincorporategovernance,andawelldevelopedstockmarketwithanassociatedmarketforcorporatecontrol.Incontrast,JapaneseandGermanbanksarefewerinnumberbutlargerinrelativesizeandaresaidtoplayacentralgovernancerole.Neithercountryhasanactivemarketforcorporatecontrol.Weextendthedebateontherelativeefficiencyofbank-andstockmarket-centeredcapitalmarketsbydevelopingafurthersystematicdifferencebetweenthetwosystems:thegreatervitalityofventurecapitalinstockmarket-centeredsystems.Understandingthelinkbetweenthestockmarketandtheventurecapitalmarketrequiresunderstandingthecontractualarrangementsbetweenentrepreneursandventurecapitalproviders;especiallytheimportanceoftheopportunitytoenterintoanimplicitcontractovercontrol,whichgivesasuccessfulentrepreneurtheoptiontoreacquirecontrolfromtheventurecapitalistbyusinganinitialpublicofferingasthemeansbywhichtheventurecapitalistexitsfromaportfolioinvestment.WealsoextendtheliteratureonventurecapitalcontractingbyofferinganexplanationfortwocentralcharacteristicsoftheU.S.venturecapitalmarket:relativelyrapidexitbyventurecapitalprovidersfrominvestmentsinportfoliocompanies;andthecommonpracticeofexitthroughaninitialpublicoffering.Keywords:VentureCapital;ExitStrategy;IPO;ComparativeCorporateGovernanceJELClassifications:G23;G32______________________________________________________________________________1Theauthorsaregratefulforhelpfulsuggestionsfromtheeditorandananonymousreferee,andfromAnantAdmanti,ErikBerglof,StephenChoi,KevinDavis,UriGeiger,VictorGoldberg,PaulGompers,JosephGrundfest,EhudKamar,MichaelKlausner,JoshuaLerner,RonaldMann,PaulPfleiderer,MarkRamsayer,CharlesSabel,AllenSchwartz,andOmriYadlin,andfromparticipantsinworkshopsatColumbiaLawSchool,HarvardLawSchool,StanfordLawSchool,theMaxPlanckInstitute(Hamburg,Germany),andtheAmericanLawandEconomicsAssociation.ResearchsupportwasprovidedbyColumbiaLawSchoolandtheRobertsPrograminLawandBusiness,StanfordLawSchool.WethankLauraMenninger,NishaniNaidoo,AnnetteSchuller,andRamVasudevanforresearchassistance.1.IntroductionContrastingcapitalmarketsintheUnitedStateswiththoseofJapanandGermanyhasbecomeacommonplaceactivity.TheUnitedStateshasalargenumberofcomparativelysmallbanksthatplayalimitedroleinthegovernanceoflargecorporations,andawelldevelopedstockmarketwithanassociatedmarketforcorporatecontrolthatfiguresprominentlyincorporategovernance.Incontrast,JapanesemainbanksandGermanuniversalbanksarefewinnumberbutlargerinsize,relativetoJapaneseandGermanfirms,andaresaidtoplayacentralcorporategovernanceroleinmonitoringmanagement(e.g.,Aoki,1994;Roe,1994).Neithercountryhasanactivemarketforcorporatecontrol.Advocatesofbank-centeredcapitalmarketsclaimthatthisstructurefosterspatientcapitalmarketsandlong-termplanning,whileastockmarket-centeredcapitalmarketissaidtoencourageshort-termexpectationsbyinvestorsandresponsiveshort-termstrategiesbymanagers(e.g.,Edwards&Fischer,1994;Porter,1992).Advocatesofstockmarket-centeredsystems(e.g.,Gilson,1996)stresstheadaptivefeaturesofamarketforcorporatecontrolwhicharelackinginbank-centeredsystems,andthelackofempiricalevidenceofshort-termism.Parallelingtheassessmentofthecomparativemeritsofstockmarketandbank-centeredcapitalmarkets,scholarshavealsosoughttoexplainhowtheUnitedStates,Germany,andJapandevelopedsuchdifferentcapitalmarkets.Recentworkhasstressedthatthecharacteristicsofthethreecapitalmarketsdonotreflectsimplytheefficientoutcomeofcompetitionbetweeninstitutions,inwhichthemostefficientinstitutionssurvive.ThenatureoftheAmericancapitalmarket--astrongstockmarket,weakfinancialintermediaries,andtheabsenceofthecloselinksbetweenbanksandnonfinancialfirmssaidtocharacterizetheJapaneseandGermancapitalmarkets--reflects,atleastinpart,politics,historyandpath-dependentevolution,ratherthaneconomicinevitability(e.g.,Black,1990;Gilson,1996;Roe,1994).MuchthesameseemstobetrueofGermanyandJapan(Hoshi,1993;Roe,1994).Tobesure,competitivelydrivenevolutionhonesefficiency,butinstitutionsthatemergeareshapedatcriticalstagesbytherandomhandofeventsandtheinstrumentalhandofpolitics.Inthisarticle,weseektocontributetotwoliteratures.First,weextendthedebateabouttherelativeefficiencyofbank-andstockmarket-centeredcapitalmarketsbydocumentingandexplainingasecondsystematicdifferencebetweenthetwosystems:theexistenceofamuchstrongerventurecapitalindustryinstockmarket-centeredsystems.Wedefineventurecapital,consistentwithAmericanunderstanding,asinvestmentbyspecializedventurecapitalorganizations(whichwecallventurecapitalfunds)inhigh-growth,high-risk,oftenhigh-technologyfirmsthatneedcapitaltofinanceproductdevelopmentorg