Financing of Innovation under Information Asymmetry

Abstract

My thesis studies the financing of innovations under information asymmetry. The growth of innovative companies requires sufficient fundings before a successful breakthrough. However, their assets are in general intangible and hard to evaluate by investors. Therefore, firms have private information about their technology and those of better qualities need to generate signals to potential funders. My thesis illustrates two of them: acquisition and contracts. HASH(0x41e62f0) In Chapter 1, I study acquisitions between startups. I document that over one third of initial public offerings (IPOs) have acquired before filing. What determines whether startups can finish such transactions? How is IPO performance related to acquisition deals? To answer these questions, I develop a continuous-time real options model of two heterogeneous startups with information asymmetry as the key frictions. I first prove that private acquisitions are positive signals for startup qualities and will reduce IPO underpricing. However, signaling opportunity is not always available. Investors' overoptimism will lead to inefficient IPO waves that inhibit signaling acquisition transactions. I confirm the model predictions by empirically finding that IPOs with private acquisitions have both significantly less underpricing and better long-term operational performance. HASH(0x41e7fc8) In Chapter 2, my adviser Martin Szydlowski and I study venture capital finance with experimentation. An entrepreneur contracts with an investor and has private information about a project, which requires costly experimentation by both parties to succeed. In equilibrium, investors learn about the project from the arrival of exogenous information and from the entrepreneur's contract offers. The optimal contract features vesting and dilution, consistent with empirical evidence. Early payouts, pivots, and prestige projects emerge as signaling devices. Surprisingly, technological progress, which lowers the cost of experimentation or which increases the rate of learning, delays separation of types and worsens adverse selection. Liquidation rights for investors also delay separation.