Abstract

Asymmetric information and agency theories of investment predict that informationally opaque firms suffer from liquidity constraints, and that these constraints are particularly severe during market downturns In this paper, we test this hypothesis by examining a sample of more than 2200 firms that were seeking venture capital (VC) financing in the European VC market between 1996 and 2001. Consistent with the asymmetric information theories, we find that young firms, firms without prior venture capital backing, and firms with unproven entrepreneurs were relatively more liquidity constrained after the market downturn in 2000. We also find evidence suggestive of behavioral theories of investment behavior. In particular, VCs started to focus more on fundamentals after the market downturn, suggesting that VCs were over-investing during the boom.

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