Reputation in Financial Intermediation: Evidence from Venture Capital

Abstract

Venture capital (VC) has emerged as one of the dominant forms of financing for technology intensive industries. Many start-ups have flourished tremendously after receiving VC funding and have gone on to become industry leaders. Prominent examples include Apple, Cisco, Intel, Genentech, and most recently Google. VCs are important financial intermediaries channeling capital from investors to risky, unproven start-ups that otherwise would face a much more uphill task trying to raise capital. What also sets them apart from other traditional financial intermediaries - banks, other institutional investors etc. - is their ability to provide expertise and other value-added services for start-ups’ development. In addition to providing expertise and value-added services that generate economic benefits, VC firms aspire to be active long-term players in the industry. These motivations critically influence and depend on VCs’ reputational capital, a precious resource in the competitive VC industry beset by considerable information asymmetries between VCs and their investors, as well as between VC firms and start-ups. That a firm’s reputation is a valuable asset which can generate future economic rents for the firm and provide its customers valuable information on products and services is well recognized (Shapiro, 1983; Wilson, 1985). This study surveys the literature on the important role of venture capitalists particularly focusing on their reputation capital and its implications for companies.