Screening and Information Asymmetry in Early-Stage Venture Capital Markets

This is an examination of early-stage capital markets among venture capital investors and entrepreneurs, and the role information asymmetry plays in influencing the strategies that market participants adopt. It explores the thesis that venture capital investors who operate in early-stage capital markets do so to attract desirable entrepreneurs, and thereby improve the quality of investment opportunities they are presented with. A combination of theoretical arguments and empirical research on venture capital investors frames the types of investors and the reasons they use to justify their operation in early-stage capital markets. An empirical study of entrepreneurs and their capital-sourcing decisions then elucidates the effect of various investor strategies on the decisions of entrepreneurs. This research suggests that venture capitalists are not homogeneous in their approach to this market, and these variations are due to differences in their ability to "screen" investment opportunities. Moreover, investors with particularly high skill will operate in this market to attempt to signal this quality to entrepreneurs, as successful operation in this market does convey private information about the investors skill. Yet, entrepreneurs do not value this signal. When selecting their capital providers, they pay little practical attention to the information this signal conveys. This research contributes to the extension of previous theoretical models of investor screening, by allowing heterogeneity in screening skill, and by developing a range of strategic alternatives that skilled investors can pursue, which are not evident in previous models. This research also contributes to an enhanced understanding of the role of signalling in financial markets with high information asymmetries, by developing a theoretical justification for the emergence of such signals, by demonstrating their formation in early-stage capital markets, and by examining their poor efficacy with respect to one of the target audiences (i.e., entrepreneurs). Finally, this research contributes a novel perspective to our understanding of how early-stage entrepreneurs evaluate potential venture capital investors, and the degree to which their own understanding of this is marred by poor introspection. Through these contributions, this research provides an improved understanding of key elements of the entrepreneurial process in relation to high-growth firms