The substitution of bonding for monitoring in venture capitalist relations with high technology enterprises

Abstract

This paper presents a theory-based rationale that new venture team managers may utilize to reduce the cost of monitoring their venture. Because monitoring is costly and is eventually charged back to the venture, the present analysis suggests that there is at least one way for managers to protect their equity stake from such assessments. Drawing on concepts from institutional economics, it is shown that the level of monitoring depends upon the level of market and agency risk associated with the investment. However, actions taken by venture managers are shown to substitute for risk-reducing measures that could be taken by venture capitalists, which would otherwise result in the reduction of the equity stake of the managers. Moreover, a willingness by team members to bond themselves to the deal may increase the value of their stake in it, whereas resorting to monitoring can only depreciate the value of their stake.