1. Cumming and Johan (2013 Chapter 15)
Contracts and Effort
Cumming and Johan (2013 Chapter 15) 1

2. Motivation Theory Data Regressions Conclusion/Summary
Corporate finance literature dominated by “incentive effects”
Vast theoretical literature
Scant empirical literature
Significant need for empirical assessment
The fundamental basis of all work in venture capital and private equity 2

3. Chapter Objectives Do contracts affect effort, and if so, how?
Motivation Theory Data Regressions Conclusion/Summary
Chapter Objectives
Do contracts affect effort, and if so, how?
Focus on venture capital contracts, syndication, legal environment
Assess total effort
Distinguish between advice and monitoring 3

4. Particular Features in this Chapter
Motivation Theory Data Regressions Conclusion/Summary
Particular Features in this Chapter
Measure actual hours of work contributed by VCs to each investee
Distinguish between VC advice and monitoring
Assess the role of specific contractual details, & syndication across VC funds, etc.
Provide very specific empirical details
Contract structures, portfolio size, entrepreneurial firm, VC, exit outcomes, etc.
Relate results to vast theoretical literature 4

5. Theoretical Focus in VC Literature
Motivation Theory Data Regressions Conclusion/Summary
Theoretical Focus in VC Literature
Cash flow rights
Control rights
Legal Systems
Control variables 5

6. Motivation Theory Data Regressions Conclusion/Summary
1. Cash Flow Rights
Casamatta (2003 JF), Schmidt (2003 JF), Farmer and Winter (1986 JF)
Bilateral moral hazard in VC finance
Role for convertible preferred shares
Hypothesis 15.1a: Venture capital fund managers provide more effort and advice to entrepreneurial firms financed with convertible securities (instead of common equity or debt). Moreover, the effort exerted by the venture capital fund manager and advice provided is directly correlated with the venture capital fund’s ownership percentage.
Concern with endogeneity
Frequent use of non-convertibles outside the US 6

7. 1. Cash Flow Rights (Continued)
Motivation Theory Data Regressions Conclusion/Summary
1. Cash Flow Rights (Continued)
Cornelli and Yosha (2003 RES)
Convertible securities mitigate signal manipulation in staged financing
Hypothesis 15.1b: There are fewer venture capital fund manager-entrepreneur conflicts within entrepreneurial firms financed with convertible securities.
Concern with endogeneity
Competing behavioral finance ideas 7

8. 2. Control Rights Chan et al. (1990 IER); Kirilenko (2001 JF)
Motivation Theory Data Regressions Conclusion/Summary
2. Control Rights
Chan et al. (1990 IER); Kirilenko (2001 JF)
Control is related to project risk
Hypothesis 15.2a: Venture capital fund managers provide more effort and advice for entrepreneurial firms for which the venture capital fund has been allocated greater control rights.
Hypothesis 15.2b: Venture capital fund manager-entrepreneur conflicts are more likely among investee firms for which the venture capital fund has been allocated greater control rights.
Concern with endogeneity
Heterogeneous allocation of control across firms 8

9. Motivation Theory Data Regressions Conclusion/Summary
3. Legal Systems
Hypothesis 15.3: Countries with better legal systems mitigate the scope for venture capital fund manager–entrepreneur conflict as better legal systems facilitate more certainty in the enforcement of contracts, as well as the interpretation of incomplete contracts. 9

10. 4. Control Variables Type of VC (captive / non-captive)
Motivation Theory Data Regressions Conclusion/Summary
4. Control Variables
Type of VC (captive / non-captive)
Portfolio size / VC Manager
Capital Managed / VC Manager
Staging
Entrepreneur stage of development
Entrepreneurial firm industry
Entrepreneur experience
Exit outcomes 10

11. Control Variables (Continued)
Motivation Theory Data Regressions Conclusion/Summary
Control Variables (Continued)
Syndication
Lerner (1994 FM), Brander et al. (2002 JEMS), Casamatta and Haritchabalet (2007 JFI)
Effort complementarities
Expect VCs work more when syndicated investors work more
Endogeneity concerns 11

12. Hand Collected Sample 121 investment rounds 74 entrepreneurial firms
Motivation Theory Data Regressions Conclusion/Summary
Hand Collected Sample
121 investment rounds
74 entrepreneurial firms
14 VC funds
7 European countries (Belgium, Denmark, Germany, Hungary, Italy, Portugal, The Netherlands) 12

13. OLS, Ordered Logit and IV Estimates
Motivation Theory Data Regressions Conclusion/Summary
OLS, Ordered Logit and IV Estimates
Dependent Variables
Hours/Month, Advice Rank, # Disagreements
Explanatory Variables
VC characteristics, ENT characteristics, Exits, Contract Terms, Risk Measures, legality, etc.
Instruments
Year of investment and exit dummies, MSCI returns over investment period
Correlations (Tables 3 and 4) work “fairly” well, but not 100% perfect 13

14. Tables 15.5 – 15.7 Table 15.5: Dep Var: Hours / Month
Motivation Theory Data Regressions Conclusion/Summary
Tables 15.5 – 15.7
Table 15.5: Dep Var: Hours / Month
Table 15.6: Dep Var: Advice Rank
Table 15.7: Dep Var: # Disagreements
5 Models per Panel to show robustness
Regressions with and without instruments
Regressions with different sets of explanatory variables 14

15. Table 15.4: Dep Variable Hours Per Month Model (1) OLS Model (2) OLS
Model (5) 2SLS
Coefficient
t-statistic
Constant
10.75
2.00*
1.43
0.17
10.20
1.02
14.87
0.46
-3.55
-0.10
Contractual Terms and Legal Conditions
Convertible Security (H1)
2.25
0.51
1.88
0.50
-3.23
-0.92
-2.22
-0.66
-10.33
-1.87**
Ownership % (H1)
4.55
0.30
20.83
1.50
25.69
2.30**
30.67
2.67***
38.76
1.64*
Veto Rights (H2)
13.44
4.98***
7.96
2.10**
11.36
3.26***
12.15
3.22***
-0.87
-0.07
Board Rights (H2)
-0.004
-0.48
-0.001
-0.15
0.003
0.65
0.002
0.44
-0.03
-0.91
Special Control Rights (H2)
-1.49
-0.23
Country Legality (H3)
-0.39
-0.50
Project and Environment Related Risk
Project Risk Ranking
-4.67
-0.56
-9.77
-1.12
-4.07
-0.46
2.51
0.29
-6.01
-0.37
Entrepreneur Experience Ranking
0.21
0.40
0.24
0.43
0.36
0.26
Late or Buyout Stage
-8.35
-2.13**
-10.50
-3.22***
-9.15
-2.47**
-7.44
-1.89*
-5.87
Medical / Biotechnology
-4.70
-5.33
-0.93
2.77
0.31
Computer / Electronics
-4.92
-1.54
-3.95
-1.13
-4.31
-0.78
Communications / Internet
-11.58
-2.82***
-11.16
-2.48**
-9.70
-1.58
Foreign Investment
0.10
-2.85
-0.63
-0.79
-0.20
1.87
0.39
2.75
Investment Characteristics and Performance
Hours from Syndicated Partners
0.49
5.60***
5.51***
0.38
5.07***
0.67
2.07**
Investment Rounds
3.81
2.59**
4.00
2.55**
1.64
0.19
(Log of) Book Value
0.72
-0.21
-0.28
-0.96
0.94
-0.06
Investment Months
-0.30
-3.35***
-3.61***
17.09
1.74**
IPO Exit
10.76
2.44**
16.26
0.25
0.03
Acquisition Exit
7.74
2.09**
Venture capital fund manager Fund Characteristics
Limited Partnership Venture capital fund manager
1.74
0.42
0.96
-2.92
0.74
3.00
0.62
Venture capital fund manager Portfolio Size / # of Venture capital fund manager Managers
-1.98
-2.53**
-1.19
-1.55
-2.39
-2.67***
-1.69
-1.88*
-3.01
-1.40
Number of Observations 74
Adjusted R2
0.47
0.48
F-statistic
1.96*
3.99***
4.57***
4.16***
2.18***

16. Table 15.5. Dep Variable Advice Ranking Model (1) OLS Model (2) OLS
Model (5) 2SLS
Coefficient
t-statistic
Constant
0.44
0.85
2.31
2.96**
1.64
3.31
1.19
-2.24
-0.72
Contractual Terms and Legal Conditions
Convertible Security (H1)
0.97
2.87***
0.83
2.59**
0.48
1.27
0.62
1.93*
-0.11
-0.19
Ownership % (H1)
-0.52
-0.53
-0.12
-0.24
-0.07
-0.09
0.09
0.04
Veto Rights (H2)
2.63
6.90***
2.57
5.63***
2.45
5.17***
3.80
3.67***
Board Rights (H2)
0.001
1.69*
1.51
1.20
-0.007
-2.61**
Special Control Rights (H2)
0.24
0.31
Country Legality (H3)
-0.64
Project and Environment Related Risk
Project Risk Ranking
1.36
2.15
2.59***
2.46
2.83***
2.30
2.60**
3.10
2.33**
Entrepreneur Experience Ranking
0.14
1.98**
1.85**
0.27
2.07**
Late or Buyout Stage
-1.34
-4.46***
-0.98
-2.92***
-0.86
-1.88**
-0.80
-1.80**
-0.48
-0.59
Medical / Biotechnology
-0.47
-0.63
-0.46
-0.68
0.32
0.33
Computer / Electronics
0.30
0.75
0.26
0.64
0.93
1.73*
Communications / Internet
-1.03
-1.50
-1.06
-1.68*
-1.10
Foreign Investment
-0.29
-0.84
-0.26
-0.74
-0.28
-0.82
0.45
0.78
Investment Characteristics and Performance
Hours from Syndicated Partners
-0.003
-0.008
-0.78
-0.77
-0.01
Investment Rounds
0.25
1.10
0.34
0.99
1.21
(Log of) Book Value
-0.25
-2.98***
-0.30
-4.13***
-3.65***
-1.95*
Investment Months
-0.006
-0.71
0.10
0.11
IPO Exit
0.12
-0.05
-0.13
0.002
2.11**
Acquisition Exit
-0.61
Venture capital fund manager Fund Characteristics
Limited Partnership Venture capital fund manager
-0.18
-0.43
-0.04
-0.16
-0.45
0.57
1.08
Venture capital fund manager Portfolio Size / # of Venture capital fund manager Managers
-0.14
-1.59
-0.22
-2.21**
-2.78***
-0.37
-1.76*
Number of Observations 74
Adjusted R2
0.38
0.40
F-statistic
6.69***
5.50***
4.02***
4.01***

17. Table 15.6. Dep. Variable Scope of Disagreement Model (1) OLS
Model (3) Ordered Logit
Model (4) Ordered Logit
Model (5) IV Ordered Logit
Coefficient
t-statistic
Constant
0.53
0.61
7.75
2.72***
3.67
1.50
9.97
2.07**
7.79
2.13**
Contractual Terms and Legal Conditions
Convertible Security (H1)
-0.04
-0.13
0.31
1.01
0.03
0.40
0.36
0.48
0.20
0.15
Ownership % (H1)
1.21
1.22
1.55
1.67*
3.14
1.14
3.03
1.76*
-0.34
-0.06
Veto Rights (H2)
0.27
0.86
-0.42
-0.95
-0.12
-0.11
-0.93
-1.17
-2.57
-0.81
Board Rights (H2)
0.83
3.27
1.15
0.002
Special Control Rights (H2)
-2.92
-1.75*
1.64
0.26
Country Legality (H3)
-0.29
-3.10***
-0.40
-2.17**
Project and Environment Related Risk
Project Risk Ranking (H2)
-0.23
-0.28
0.41
0.49
0.73
0.34
0.14
-0.89
Entrepreneur Experience Ranking (H2)
-0.16
-1.83*
-0.39
-1.81*
-0.32
-1.84*
-2.35**
Late or Buyout Stage (H2)
-0.88
-2.83***
-1.09
-2.76
-2.46**
-1.30
-1.08
-2.15
-2.02**
Medical / Biotechnology (H2)
1.43
1.93
1.45
1.10
0.93
-0.08
-0.05
Computer / Electronics (H2)
-0.33
-0.90
0.44
-0.09
-0.47
-0.41
Communications / Internet (H2)
-0.78
-1.80*
-1.05
-1.29
-1.38
-1.19
Foreign Investment
0.21
0.60
1.19
0.81
0.75
0.78
-0.58
-0.25
Investment Characteristics and Performance
Hours from Syndicated Partners
3.72***
4.00***
0.09
2.24**
0.06
2.40**
0.02
Investment Rounds
0.16
-0.84
0.13
-2.38**
(Log of) Book Value
0.33
0.19
0.90
0.12
0.50
Investment Months
-0.01
-1.87*
-1.35
-0.02
-1.02
1.96
1.38
IPO Exit
-0.14
0.43
0.52
Acquisition Exit
Venture capital fund manager Fund Characteristics
Limited Partnership Venture capital fund manager
-0.98
-2.24**
-0.53
-0.62
-1.23
-1.43
-0.61
-0.82
Venture capital fund manager Portfolio Size / # of Venture capital fund manager Managers
-3.22***
-0.18
-2.20**
-0.79
-1.91*
-0.74
-1.55
Mu (1)
0.95
3.03***
0.84
2.74***
0.66
2.96***
Mu (2)
1.30
2.41**
1.20
3.10***
3.42***
Mu (3)
2.59
2.52**
2.60
3.09***
2.01
3.37***
Mu (4)
3.69
2.78***
3.77
2.98
2.35**
Number of Observations 74
Adjusted R2 (Pseudo R2 for Models (3) – (5))
0.32
0.38
F-statistic (Chi-square for Models (3) – (5))
2.44**
2.81***
Chi-squared: ***
Chi-squared: ***
Chi-squared: ***

18. Explanatory Variables
Impact on
Total hours effort
Advice
Disagreement
Use of Convertible Securities +
VC Ownership %
+ / 0
Veto Rights
Board Rights
Syndication
Early Stage
Project Risk
Entrepreneur Experience -
VC Portfolio Size / # Managers
Success Potential
Length of Investment Period
Legality
‘+’ refers to robust positive effect, ‘-’ refers to robust negative effect, 0 refers to no significant impact, and ‘+ / 0’ refers to positive but non-robust estimates.

19. Summary Rare direct look at investor activities
Motivation Theory Data Regressions Conclusion/Summary
Summary
Rare direct look at investor activities
Important aspect of most theory papers
Prior empirical papers tend to look at effect of effort, not actual effort
Novel empirical approach in distinguishing between advice and monitoring
Advice: congruent with entrepreneurial interests
Monitoring: dissonant with entrepreneur interests 19

20. Motivation Theory Data Regressions Conclusion/Summary
Key Findings (1)
Cash-flow and control rights enhance advice but not monitoring.
Supports Casamatta (2003 JF), Repullo and Suarez (2003 RES), Schmidt (2003 JF), De Bettignies (2008 MS)
Does not support Cornelli and Yosha (2003 RES), although not a direct test of that model 20

21. Complementarities in VC Syndicate effort
Motivation Theory Data Regressions Conclusion/Summary
Key Findings (2)
Complementarities in VC Syndicate effort
Supports Lerner (1994 FM), Brander et al (2002 JEMS)
Complementarities in VC-Entrepreneur effort
Supports Casamatta (2003 JF), Cestone (2013 RF), Repullo and Suarez (2004 RF) 21

22. Motivation Theory Data Regressions Conclusion/Summary
Key Findings (3)
Strong and robust negative relation between VC portfolio size/manager and involvement
Funds with larger portfolios per manager tend to provide less effort in both advising and monitoring.
Consistent with
Kanniainen and Keuschnigg (2004 JCF, JBF)
Keuschnigg (2004 OEP)
Cumming (2006 J Bus) 22

23. Motivation Theory Data Regressions Conclusion/Summary
Key Findings (4)
Better legal systems mitigate VC-Entrepreneur conflicts
Consistent with evidence in other parts of book on the importance of legality in the development of VC markets 23