Information Asymmetry and Reputation Effects on the Strategies and Performance of Venture Capitals

In this paper, we study the rational behaviors of venture firms in response to the market strategies by extending the reputation model developed by Alexeev and Kim (2004) and Kim (2013) on the basic valuation models of venture firms based on corporate financial performances. In the setup, the performances of lending institutions depend on the performances of borrowing venture firms. We introduce different levels of risk premium, revenue and cost structure, etc. in addition to prior studies with four types of rational venture firm behavior in their steady-state that try to maximize the chances of credit-financing at a cheaper cost and studying the decision of venture capitals as an indicator of their market type to seek high-quality venture firms at lower risk premium and low-quality venture firms at higher risk premium. We find that a venture capital is more likely to provide funds at a higher interest rate, including risk premium in a no-competition capital market, than in the competing capital market for venture firms. In the latter, more than two venture capitals competitively play opposite strategies to win more venture firms. Furthermore, in the competitive market, a venture capital is more likely to provide funds at a higher interest rate, including risk premium as the competition in the market intensifies and information sharing among players can play a critical role.