COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 1682

Venture Capital and Sequential Investments

Dirk Bergemann, Ulrich Hege and Liang Peng

November 2008

We analyze sequential investment decisions in an innovative project that depend on the investor's information about the project failure risk and its potential final value. We consider the feedback effects between learning about the project parameters and the continuous adjustment of the investment strategy. Investors decide sequentially about the speed of investment and the optimal degree of involvement. We develop three types of predictions from our theoretical model and test these predictions in a large sample of venture capital investment in the U.S. for the period of 1987-2002.

First, the investment flow starts cautiously if the failure risk is high and accelerates as the projects mature. Second, the investment flow reacts positively to information that arrives while the project is developed. We find that interim information is more significant for investment decisions than the information prior to the project launch. Third, investors distribute their investments over more funding rounds if the failure risk is larger.

Keywords: Venture Capital, Sequential investment, Stage financing, Intertemporal returns

JEL Classification: D83, D92, G11, G24