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uh firms reach out to external financial
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markets for additional capital
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throughout their life cycles. At the
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very early stage, it is venture
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capitalists that provide both guidance
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and capital to young entrepreneurs. At
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the later stage, big private equity
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firms and public markets provide
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additional financing for more mature
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firms. External financing is crucial for
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the firm's growth. It allows financially
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constrained entrepreneurs to develop and
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later bring their uh new ideas to the
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market. It also allows public mature
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companies to invest into new and
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profitable
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projects. However, external financing is
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costly due to the problem known as
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adverse selection. In short, investors
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are willing to provide financing on
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terms that reflect expected or the
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average firm quality. This implies that
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issuances of firms that are better than
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average will uh might be underpriced.
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This problem is particularly pronounced
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for the firms uh that either have no
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history of cash flows or no tangible
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assets such as startups at the very
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early stage of development.
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Entrepreneurs on the other hand have
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better information about both their own
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abilities and the quality of these
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ideas. This makes the market for venture
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capital financing a great laboratory for
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analyzing adverse selection. So in my
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research I ask the question how uh does
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the quality of projects that receive
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financing and the liquidity in this
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funding market response to the exogenous
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changes in the cost of investors
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capital. In other words, I analyze how
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the projects that raise funds in hot
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markets are different from those that
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raise funds in cold markets and how the
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fundraising process itself differs
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across the two market conditions.
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The key takeaway is that in cold market
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conditions, entrepreneurs and firms with
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projects above the average quality
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strategically delay their fundraising
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decisions. This delay serves as an
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informative signal for investors and
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allows the companies to secure better
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terms of financing at a later date.
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The worst quality firms on the other
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hand prefer to raise funds earlier albe
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at the less attractive prices. In
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contrast, in the hot market conditions,
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both high and low quality firms raise
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funds immediately regardless of the
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quality. This pooling of high and low
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firms together results in the
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overpricing of the letter and attracts
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more lowquality firms to the market.
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Another interesting finding of this
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research is that firms and entrepreneurs
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strongly react to changes in the
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investment conditions. For example, a
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decline in the investors cost of
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capital decreases the incentives of
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entrepreneurs to strategically delay
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their fundraising and signal their type.
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This triggers a wave of high quality
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deals at the onset of hot markets.
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In the public debate about the optimal
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size of say venture capital industry,
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the most popular arguments tends to
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focused on the negative consequences of
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the hot market conditions, namely on
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millions of dollars spent on
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unprofitable ventures. My research shows
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that indeed tighter market conditions do
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deter some entrepreneurs with lowquality
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projects from entering the market.
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However, they also create disturbances
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at the higher end of the uh quality.
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Namely, it is the entrepreneurs and
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firms with very high quality projects
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that delay their fundraising or even
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forgo the projects
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altogether. Thus, any uh policy aiming
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at regulating such markets has to take
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into account both inefficiencies arising
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in cold and hot markets at the same
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time.
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Well, the most natural follow-up to my
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research on capital markets with adverse
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selection is actually to directly
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analyze possible policy regulations
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aiming to reduce inefficiencies in these
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markets. And theoretical model allows me
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not only to analyze the direct
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consequences of such policies but also
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to take into account for the unintended
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consequences that arise from the
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equilibrium response of market uh market
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participants on such regulations.
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Another interesting venue would be to
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think deeper
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about designing strategic information
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environments instead of taking them as
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given. For example, one can think about
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the stress test of banks as additional
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information that regulators provide to
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the public and to the market
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participants in order to affect their
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beliefs about the stability of the
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financial system. The natural questions
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here concerns about the structure of the
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such signals and their optimal timing of
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those
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[Music]
