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Incomplete contracting

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Business Organizations Law

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The Role Of Independent Directors In Startup Firms, Brian Broughman Jan 2010

The Role Of Independent Directors In Startup Firms, Brian Broughman

Articles by Maurer Faculty

This Article develops a new theory to explain the widespread use of independent directors in the governance of startup firms. Privately held startups often assign a tie-breaking board seat to a third-party independent director. This practice cannot be explained by the existing corporate governance literature, which relies on diffuse ownership and passive investment-features unique to the publicly traded firm. To develop an alternative theory, I model a financing contract between an entrepreneur and a venture capital investor. I show that allocating a tie- breaking vote to an unbiased thirdparty can prevent opportunistic behavior that would occur ifthe firm were controlled ...


Renegotiation Of Cash Flow Rights In The Sale Of Vc-Backed Firms, Brian Broughman, Jesse Fried Jan 2010

Renegotiation Of Cash Flow Rights In The Sale Of Vc-Backed Firms, Brian Broughman, Jesse Fried

Articles by Maurer Faculty

Incomplete contracting theory suggests that VC cash flow rights - including liquidation preferences - may be subject to renegotiation. Using a hand-collected dataset of sales of Silicon Valley firms, we find common shareholders do sometimes receive payment before VCs' liquidation preferences are satisfied. However, such deviations tend to be small. We also find that renegotiation is more likely when governance arrangements, including the firm's choice of corporate law, give common shareholders power to impede the sale. Our study provides support for incomplete contracting theory, improves understanding of VC exits, and suggests that choice of corporate law matters in private firms.