Protective covenants as a safeguard in interfirm relationships

Abstract

Entrepreneurial firms face a trade-off when receiving corporate venture capital (CVC) funding. On the one hand, entrepreneurial firms may need to abdicate some ownership or sufficient control to motivate corporate investors providing complementary assets that tend to be difficult to obtain from other sources. However, the strategic goals of corporate investors are also likely to raise the opportunism and misappropriation concerns. In this study, we demonstrate that negative protective covenants can provide a way to safeguard one party against cooperation hazards without hurting the other partner’s incentive to put sufficient efforts and resources to the interfirm relationship. By examining 296 contracts of rounds that entrepreneurial firms first receiving CVC financings, we found the ownership power, prestige power, and absorptive capability of corporate investors as well as the quality of entrepreneurial firms are positively related to the veto power of other IVC syndicates to curb potential hazards of the interfirm relationships.