Venture capital and the structure of capital marke

*Correspondingauthor.Tel.:[phone];fax:[phone];e-mail:[e-mail].1Theauthorsaregratefulforhelpfulsuggestionsfromtheeditorandananonymousreferee,andfromAnantAdmati,ErikBerglof,StephenChoi,KevinDavis,UriGeiger,VictorGoldberg,PaulGompers,JosephGrundfest,EhudKamar,MichaelKlausner,JoshuaLerner,RonaldMann,PaulPßeiderer,MarkRamsayer,CharlesSabel,AllenSchwartz,andOmriYadlin,andfromparticipantsinworkshopsatColumbiaLawSchool,HarvardLawSchool,StanfordLawSchool,theMaxPlanckInstitute(Hamburg,Germany),andtheAmericanLawandEconomicsAssociation.Re-searchsupportwasprovidedbyColumbiaLawSchoolandtheRobertsPrograminLawandBusiness,StanfordLawSchool.WethankLauraMenninger,NishaniNaidoo,AnnetteSchuller,andRamVasudevanforresearchassistance.JournalofFinancialEconomics47(1998)243Ð277Venturecapitalandthestructureofcapitalmarkets:banksversusstockmarkets1BernardS.Black!,*,RonaldJ.Gilson!,!ColumbiaUniversitySchoolofLaw,NewYork,NY10027,USAStanfordUniversitySchoolofLaw,Stanford,California94305,USAReceived18July1996;accepted29August1997AbstractTheUnitedStateshasmanybanksthataresmallrelativetolargecorporationsandplayalimitedroleincorporategovernance,andawelldevelopedstockmarketwithanassociatedmarketforcorporatecontrol.Incontrast,JapaneseandGermanbanksarefewerinnumberbutlargerinrelativesizeandaresaidtoplayacentralgovernancerole.Neithercountryhasanactivemarketforcorporatecontrol.Weextendthedebateontherelativee¦ciencyofbank-andstockmarket-centeredcapitalmarketsbydevelopingafurthersystematicdi¤erencebetweenthetwosystems:thegreatervitalityofventurecapitalinstockmarket-centeredsystems.Understandingthelinkbetweenthestockmarketandtheventurecapitalmarketrequiresunderstandingthecontractualarrange-mentsbetweenentrepreneursandventurecapitalproviders;especially,theimportanceoftheopportunitytoenterintoanimplicitcontractovercontrol,whichgivesasuccessfulentrepreneurtheoptiontoreacquirecontrolfromtheventurecapitalistbyusinganinitialpublico¤eringasthemeansbywhichtheventurecapitalistexitsfromaportfolioinvestment.Wealsoextendtheliteratureonventurecapitalcontractingbyo¤eringanexplanationfortwocentralcharacteristicsoftheU.S.venturecapitalmarket:relativelyrapidexitbyventurecapitalprovidersfrominvestmentsinportfoliocompanies;andthe0304-405X/98/$19.00(1998ElsevierScienceS.A.AllrightsreservedPIIS0304-405X(97)00045-7commonpracticeofexitthroughaninitialpublico¤ering.(1998ElsevierScienceS.A.Allrightsreserved.JELclassiÞcation:G23;G32Keywords:VentureCapital;ExitStrategy;IPO;Comparativecorporategovernance1.IntroductionContrastingcapitalmarketsintheUnitedStateswiththoseofJapanandGermanyhasbecomeacommonplaceactivity.TheUnitedStateshasalargenumberofcomparativelysmallbanksthatplayalimitedroleinthegovernanceoflargecorporations,andawelldevelopedstockmarketwithanassociatedmarketforcorporatecontrolthatÞguresprominentlyincorporategovernance.Incontrast,JapanesemainbanksandGermanuniversalbanksarefewinnumberbutlargerinsize,relativetoJapaneseandGermanÞrms,andaresaidtoplayacentralcorporategovernanceroleinmonitoringmanagement(e.g.,Aoki,1994;Roe,1994).Neithercountryhasanactivemarketforcorporatecontrol.Advocatesofbank-centeredcapitalmarketsclaimthatthisstructurefosterspatientcapitalmarketsandlong-termplanning,whileastockmarket-centeredcapitalmarketissaidtoencourageshort-termexpectationsbyinvestorsandresponsiveshort-termstrategiesbymanagers(e.g.,EdwardsandFischer,1994;Porter,1992).Advocatesofstockmarket-centeredsystems(e.g.,Gilson,1996)stresstheadaptivefeaturesofamarketforcorporatecontrolwhicharelackinginbank-centeredsystems,andthelackofempiricalevidenceofshort-termism.Parallelingtheassessmentofthecomparativemeritsofstockmarketandbank-centeredcapitalmarkets,scholarshavealsosoughttoexplainhowtheUnitedStates,Germany,andJapandevelopedsuchdi¤erentcapitalmarkets.Recentworkhasstressedthatthecharacteristicsofthethreecapitalmarketsdonotreßectsimplythee¦cientoutcomeofcompetitionbetweeninstitutions,inwhichthemoste¦cientinstitutionssurvive.ThenatureoftheAmericancapitalmarketÐastrongstockmarket,weakÞnancialintermediaries,andtheabsenceofthecloselinksbetweenbanksandnonÞnancialÞrmssaidtocharacterizetheJapaneseandGermancapitalmarketsÐreßects,atleastinpart,politics,historyandpath-dependentevolution,ratherthaneconomicinevitability(e.g.,Black,1990;Gilson,1996;Roe,1994).MuchthesameseemstobetrueofGermanyandJapan(Hoshi,1993;Roe,1994).Tobesure,competitivelydrivenevolutionhonese¦ciency,butinstitutionsthatemergeareshapedatcriticalstagesbytherandomhandofeventsandtheinstrumentalhandofpolitics.Inthisarticle,weseektocontributetotwoliteratures.First,weextendthedebateabouttherelativee¦ciencyofbank-andstockmarket-centeredcapitalmarketsbydocumentingandexplainingasecondsystematicdi¤erencebetween244B.S.Black,R.J.Gilson/JournalofFinancialEconomics47(1998)243Ð277thetwosystems:theexistenceofamuchstrongerventurecapitalindustryinstockmarket-centeredsystems.WedeÞneÔventurecapitalÕ,consistentwithAmericanunderstanding,asinvestmentbyspecializedventurecapitalorganizations(whichwecallÔventurecapitalfundsÕ)inhigh-gro