Study On Adverse Selection Between Venture Capitalists And Entrepreneurs

Venture capital is the result of combination of technology and capital, based on the economy of knowledge. Evidence shows that venture capital plays a very important role for the transformation of high-tech and the improvement of companies'innovation abilities. To develop the industry of venture capital should be a great economic strategy in China.One notable characteristic of venture capital is the highly informational asymmetry between involved parties. During the operation of capital, the venture capitalists are clients and the entrepreneurs are agents. The informational asymmetry between them will influence the choice of projects directly and then the future return of venture businesses. Because entrepreneurs are specialists and have much experience in the very field, they have more information about their actual abilities, the quality of projects and the prospect of markets. The informational asymmetry will cause serious adverse selection of venture capitalists. The result is that the entrepreneurs with high ability and good project will quit the market for lack of support from venture capitalists, then the market will break down. Based on this understanding, the paper uses information economics and game theory and set up information exchange model to study the adverse selection problem between venture capitalists and entrepreneurs deeply and systemically.At the beginning, the paper summarizes the basic principles of venture capital, including the definition,characteristics, functions, the involved parties and their relationship,the operation process of money,and the decision-making procedure. Then, by introducing the informational asymmetry theory, it explains the reasons and expression forms of information asymmetry between venture capitalists and entrepreneurs, and builds a model to analyze consequence of adverse selection. Following that,it comes up with methods to solve the adverse selection from both the microscopic project choosing and the macroscopic policy suggestion. For microscopic project choosing, by using the level of business plan and proportion of residual claim as signals,it sets up signaling model and screening model respectively to study the game process and action selection between venture capitalists and entrepreneurs,and presents an arrangement mechanism of separate balanced contract. For macroscopic policy suggestion,it comes up with several proposals to prevent the risk of adverse selection ,including improving the venture capital market transaction system,developing professional venture capital organizations,encouraging innovation of equity market and building healthy credit system. At last,it concludes the whole content and expects the directions of future study.The study in this paper is a profitable exploration of adverse selection between venture capitalists and entrepreneurs and can be a theoretical reference to the investment decision-making of venture capital organizations and development of China's venture capital market.