Venture Capital, Corporate Governance, and Firm Value PDF

Maik Kleinschmidt
Venture Capital, Corporate Governance, and Firm Value

GABLER EDITION WISSENSCHAFT
Maik Kleinschmidt
Venture Capital,
Corporate Governance,
and Firm Value
With a foreword by Prof. Dr. Alexander Bassen
Deutscher Universitäts-Verlag
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Dissertation Universität Hamburg, 2006
1. Auflage März 2007

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Foreword
Venture capital has become an important driver of economic growth in Europe during
the last decades. Corporate governance is a key success factor for the development of
private growth companies and thereby for the achievement of the venture capitalists'
financial objectives. Despite the high relevance of corporate governance for venture
capital-financed companies the topic has so far not been extensively researched. Tradi-
tional research on corporate governance focussed almost entirely on public companies.
Maik Kleinschmidt aims in his dissertation at narrowing the knowledge gap by analy-
sing the relationship between venture capital, corporate governance and firm value for
the first time in a systematic way. He researches how venture capitalists influence the
corporate governance of their portfolio companies. Factors that determine the influ-
ence and the impact are analysed in detail. In a second step, the impact of good
corporate governance on the firm value of the portfolio companies is researched.
The underlying research design is developed to ensure that the particularities of corpo-
rate governance of growth companies are captured. It incorporates both, a theoretical
and an empirical analysis. The comprehensive research concept and the corresponding
hypotheses are derived from an economic and a managerial theory. Thereby, the
control as well as the value-adding role of corporate governance is taken into account.
Empirical testing of the theoretical findings is done with qualtiative and quantitative
analyses. State-of-the-art methods are used to allow for the characteristic development
of growth companies.
With its sophisticated and novel research design, the dissertation contributes
extensively to the emerging international theoretical and empirical literature on
venture capital and corporate governance. It equally provides significant insight for
venture capitalists and managers of portfolio companies. This will, without doubt,
become widely accepted by researchers and practitioners and should give impetus to
further research on this topic.
Prof. Dr. Alexander Bassen
V
Acknowledgements
This dissertation has been written during my time as research assistant to the Chair for
Business Administration with Concentration in Investments and Finance (Prof. Dr.
Alexander Bassen) at the University of Hamburg. Based on my dissertation, I initiated
a joint project with researchers from Gent University and the University of
Nottingham that was supported by the European Venture Capital Association (EVCA)
and the Deutsches Venture Capital Institut (DVCI). I would like to take the
opportunity to thank all those who contributed to the dissertation, either directly of
indirectly.
First of all, I would like to thank my supervisor Prof. Dr. Alexander Bassen for the
interesting time at the chair and the full support of my dissertation project. The
discussions with him and his guidance were highly valuable for setting the topic and
reach of the dissertation as well as for its realization. I thank Prof. Dr. Michael Zerres
for the immediate willingness to take over the role of the second examiner of my
dissertation.
Second, the dissertation was significantly advanced by advice and support from Prof.
Dr. Sophie Manigart and Prof. Dr. Lutgart van den Berghe from Gent University and
Prof. Dr. Mike Wright from the University of Nottingham. Their critical but bene-
volent comments were very important for the theoretical and empirical parts of the
research. Together with their research assistants Tom Baelden and Christophe
Spaenjers, they made the international empirical analysis possible. In addition, the
discussions with other researchers and Ph.D. students who took part in the
Gate2Growth Doctoral Seminar on Entrepreneurship, Finance and Technology
2004/05 as well as in the doctoral consortia of the Babson Kaufmann Entrepreneurship
Research Conference 2005 and the Annual Meeting of the Academy of Management
2005 were very valuable for me. Furthermore, the feedback on my presentations of the
initial results at the research conferences G-Forum 2005 and the International
Entrepreneurship Research Conference 2005 helped to redefine the research concept.
Third, the dissertation would not have been possible without the support from EVCA
and DVCI. In particular, EVCA's research director Georges Noël — who initiated the
idea to extend the German analysis to Europe — was always available for support of
the project.
VII
Fourth, I would like to thank all participants of the empirical analyses. More than 150
managers of venture capital firms and portfolio companies took their time for an inter-
view or for completing a questionnaire. Their answers were the basis for the
dissertation and enabled me to gain insight into the relation of corporate governance
and venture capital.
Finally, and most importantly, this dissertation was only possible with the encourage-
ment and patience from my family and friends. I am most indebted to my parents for
their neverending support during my studies. For his devotion and tolerance I express
my deepest gratitude to Leif.
Maik Kleinschmidt
VIII
Contents
1 Introduction______________________________________________________ 1
1.1 Relevance of the Topic _______________________________________ 1
1.2 Literature Review____________________________________________ 2
1.2.1 Foundations of Research on Venture Capital and Corporate
Governance ________________________________________________ 3
1.2.2 Venture Capitalists' Influence on Corporate Governance _____________ 4
1.2.2.1 Reasons ___________________________________________________ 4
1.2.2.2 Factors ____________________________________________________ 5
1.2.2.3 Instruments_________________________________________________ 6
1.2.3 Effects of Venture Capitalists' Influence on Corporate Governance _____ 7
1.2.3.1 Managers __________________________________________________ 7
1.2.3.2 Boards ____________________________________________________ 8
1.2.3.3 Reporting Discipline _________________________________________ 9
1.2.4 Effects of Corporate Governance on Firm Value____________________ 9
1.3 Aims of the Research ________________________________________ 10
1.4 Research Approach _________________________________________ 12
1.5 Structure of the Research _____________________________________ 15
2 Foundations of Venture Capital and Corporate Governance_____________ 17

2.1 Introduction of Venture Capital ________________________________ 17
2.1.1 Definition _________________________________________________ 17
2.1.2 Characteristics _____________________________________________ 18
2.1.3 The Venture Capital Value Chain ______________________________ 20
2.1.3.1 Fundraising _______________________________________________ 21
2.1.3.2 Deal Sourcing and Screening__________________________________ 23
2.1.3.3 Contracting________________________________________________ 25
2.1.3.4 Venture Management________________________________________ 26
2.1.3.5 Exit______________________________________________________ 27
IX
2.1.4 Development Status of the Venture Capital Industry _______________ 28
2.1.4.1 Emergence of the Industry ____________________________________ 28
2.1.4.2 Development of Investments __________________________________ 29
2.2 Introduction of Corporate Governance __________________________ 32
2.2.1 Definition _________________________________________________ 32
2.2.2 Elements__________________________________________________ 33
2.2.2.1 Shareholder Rights__________________________________________ 35
2.2.2.2 Management_______________________________________________ 35
2.2.2.3 Board ____________________________________________________ 36
2.2.2.4 Reporting and Auditing ______________________________________ 37
2.2.3 Functions _________________________________________________ 37
2.2.4 Influencing Powers _________________________________________ 39
3 Theoretical Foundations___________________________________________ 43
3.1 Agency Theory ____________________________________________ 43
3.1.1 Introduction _______________________________________________ 43
3.1.1.1 Origination ________________________________________________ 43
3.1.1.2 Assumptions_______________________________________________ 44
3.1.2 Venture Capital and Corporate Governance ______________________ 47
3.1.2.1 Understanding of Corporate Governance_________________________ 47
3.1.2.2 Importance of Corporate Governance for Growth Companies ________ 47
3.2 Dynamic Resource-based View ________________________________ 53
3.2.1 Introduction _______________________________________________ 53
3.2.1.1 Origination ________________________________________________ 53
3.2.1.2 Assumptions_______________________________________________ 54
3.2.2 Venture Capital and Corporate Governance ______________________ 59
3.2.2.1 Understanding of Corporate Governance_________________________ 59
3.2.2.2 Importance of Corporate Governance in Growth Companies _________ 60
X
4 Relationship between Venture Capital, Corporate Governance and Firm
Value __________________________________________________________ 63
4.1 Reasons for Venture Capitalists’ Influence on Corporate Governance __ 63
4.1.1 Risk Reduction_____________________________________________ 64
4.1.1.1 Extent of Agency Risk _______________________________________ 64
4.1.1.2 Extent of Business Risk ______________________________________ 66
4.1.2 Value Creation _____________________________________________ 70
4.1.3 Exit Preparation ____________________________________________ 73
4.1.4 Development of Reasons for Influence __________________________ 74
4.2 Effects of Venture Capitalists’ Influence on Corporate Governance____ 76
4.2.1 Management_______________________________________________ 76
4.2.1.1 Assessment and Selection of Managers __________________________ 76
4.2.1.2 Bonding of Managers________________________________________ 80
4.2.1.3 Compensation of Managers ___________________________________ 81
4.2.2 Board ____________________________________________________ 85
4.2.2.1 Composition_______________________________________________ 85
4.2.2.2 Work ____________________________________________________ 92
4.2.3 Reporting Discipline ________________________________________ 96
4.3 Abilities of Venture Capitalists To Influence Corporate Governance ___ 99
4.3.1 Control Rights _____________________________________________ 99
4.3.2 Characteristics of Venture Capitalists __________________________ 101
4.3.2.1 Characteristics of Venture Capital Firms________________________ 102
4.3.2.2 Characteristics of Investment Managers ________________________ 105
4.3.3 Trust ____________________________________________________ 108
4.4 Effects of Corporate Governance on Firm Value__________________ 109
4.4.1 Theoretical Explanation _____________________________________ 109
4.4.2 Fundamental Performance ___________________________________ 110
4.4.2.1 Profitability ______________________________________________ 111
XI
4.4.2.2 Growth __________________________________________________ 114
4.4.3 Valuation ________________________________________________ 115
5 Empirical Analyses ______________________________________________ 119

5.1 Research Concept _________________________________________ 119
5.2 Qualitative Analysis________________________________________ 124
5.3 Methods of the Quantitative Analysis __________________________ 129
5.3.1 Data Sources _____________________________________________ 129
5.3.1.1 Survey __________________________________________________ 130
5.3.1.2 Database_________________________________________________ 136
5.3.2 Variables ________________________________________________ 137
5.3.2.1 Reasons _________________________________________________ 137
5.3.2.2 Effects on Corporate Governance Quality _______________________ 138
5.3.2.3 Abilities _________________________________________________ 139
5.3.2.4 Effects on Firm Value ______________________________________ 140
5.3.3 Statistical Methods_________________________________________ 141
5.3.3.1 Descriptive Analyses _______________________________________ 142
5.3.3.2 Multivariate Analyses ______________________________________ 142
5.3.4 Representativeness_________________________________________ 146
5.3.5 Basic Information on Respondents ____________________________ 147
5.3.6 Basic Information on Invested Venture Capitalists ________________ 150
5.3.7 Perceived Relationship Between Venture Capital, Corporate
Governance and Firm Value _________________________________ 153
5.4 Reasons for Venture Capitalists' Influence on Corporate Governance _ 154
5.4.1 Descriptive Results for Development of Reasons and Influence ______ 154
5.4.1.1 Risk Reduction____________________________________________ 154
5.4.1.2 Value Creation ____________________________________________ 155
5.4.1.3 Exit Preparation ___________________________________________ 155
5.4.1.4 Strength of Influence _______________________________________ 155
XII
5.4.2 Results for Hypotheses’ Tests ________________________________ 157
5.4.2.1 Risk Reduction____________________________________________ 157
5.4.2.2 Value Creation ____________________________________________ 159
5.4.2.3 Exit preparation ___________________________________________ 161
5.4.2.4 Development of Reasons ____________________________________ 162
5.5 Effects of Venture Capitalists' Influence on Corporate Governance ___ 164
5.5.1 Descriptive Results for the Development of Corporate Governance
Quality __________________________________________________ 164
5.5.2 Results for Hypotheses’ Tests ________________________________ 168
5.6 Abilities of Venture Capitalists' to Influence Corporate Governance __ 176
5.6.1 Descriptive Results for Venture Capitalists' Abilities ______________ 176
5.6.2 Results for Hypotheses' Tests ________________________________ 178
5.7 Effects of Corporate Governance on Firm Value__________________ 189
5.7.1 Descriptive Results for Development of Firm Value_______________ 189
5.7.2 Results for Hypotheses' Tests ________________________________ 192
6 Conclusion _____________________________________________________ 199

6.1 Summary of Results________________________________________ 199
6.1.1 Influence of Venture Capital on Corporate Governance ____________ 200
6.1.2 Influence of Corporate Governance on Firm Value________________ 203
6.2 Discussion _______________________________________________ 205
6.2.1 Limitations of the Analyses __________________________________ 205
6.2.2 Interpretation of Results_____________________________________ 207
6.2.2.1 Influence of Venture Capitalists on Corporate Governance _________ 207
6.2.2.2 Influence of Corporate Governance on Firm Value________________ 211
6.3 Outlook _________________________________________________ 212
XIII
Figures
Figure 1: Structure of the thesis________________________________________ 15
Figure 2: Influence of venture capitalists on portfolio companies _____________ 20
Figure 3: Venture capital value chain ___________________________________ 20
Figure 4: Newly invested capital in Europe 2005 by investor type_____________ 23
Figure 5: Development phases of growth companies _______________________ 24
Figure 6: Volume of funds raised and investments in Europe 1995–2005 _______ 30
Figure 7: Funds raised by type of venture capitalist in Europe 2001–2005 ______ 30
Figure 8: Investments by financing phase in Europe 2001–2005 ______________ 31
Figure 9: Elements of good corporate governance _________________________ 34
Figure 10: Main functions of corporate governance elements _________________ 39
Figure 11: Influencing powers of corporate governance______________________ 41
Figure 12: Relationship between reasons and venture capitalists' influence _______ 76
Figure 13: Relationship between venture capitalists' influence and corporate
governance ________________________________________________ 98
Figure14: Relationship between venture capitalists' abilities and impact on
corporate governance _______________________________________ 109
Figure 15: Relationship between impact on corporate governance and firm value_ 117
Figure 16: Research concept __________________________________________ 119
Figure 17: Overview of hypotheses about the relationship between venture
capitalists' reasons and influence on corporate governance __________ 120
capitalists' influence and the quality of corporate governance________ 122
capitalists' abilities and the quality of corporate governance_________ 123
Figure 20: Overview of hypotheses about the relationship between the quality of
corporate governance and firm value___________________________ 124
Figure 21: Overview of interviews _____________________________________ 125
Figure 22: Overview of information collected with questionnaire _____________ 132
Figure 23: Comparison of original sample and respondents __________________ 136
Figure 24: Comparison of two measures for corporate governance quality ______ 139
Figure 25: Respondents by number of financing rounds_____________________ 147
Figure 26: Respondents by development stage ____________________________ 148
Figure 27: Respondents by age group ___________________________________ 149
Figure 28: Respondents by number of employees__________________________ 149
Figure 29: Respondents by industry ____________________________________ 150
XV
Figure 30: Venture capitalists by type___________________________________ 151
Figure 31: Venture capitalists by international scope _______________________ 151
Figure 32: Venture capitalists by number of portfolio companies _____________ 152
Figure 33: Number of contacts between venture capitalists and portfolio
companies _______________________________________________ 152
Figure 34: Mean respondents' perception of the impact of venture capitalists and ___
good corporate governance __________________________________ 153
Figure 35: Development of agency and business risk over time _______________ 154
Figure 36: Development of overall venture capitalists' influence on corporate
governance _______________________________________________ 156
Figure 37: Development of venture capitalists' influence on corporate governance
elements _________________________________________________ 156
Figure 38: Overview of the results for hypotheses about the relationship between
venture capitalists' reasons and influence on corporate governance ___ 163
Figure 39: Development of corporate governance quality — self-assessment ____ 164
Figure 40: Development of corporate governance quality — criteria ___________ 165
Figure 41: Development of the quality of the corporate governance monitoring
function _________________________________________________ 166
Figure 42: Development of the quality of the corporate governance bonding
function _________________________________________________ 166
Figure 43: Development of the quality of the corporate governance advice
function _________________________________________________ 167
Figure 44: Development of the quality of corporate governance elements — self
assessment _______________________________________________ 167
Figure 45: Development of the quality of corporate governance elements —
criteria __________________________________________________ 168
the venture capitalists' influence and corporate governance quality ___ 175
Figure 47: Index of venture capitalists abilities' over time ___________________ 176
Figure 48: Subindexes of venture capitalists' abilities over time ______________ 177
Figure 49: Trust between investment managers and portfolio companies'
managers over time ________________________________________ 177
venture capitalists' abilities and corporate governance quality _______ 188
Figure 51: Development of portfolio companies’ competitiveness_____________ 189
Figure 52: Development of portfolio companies’ profitability measures ________ 190
Figure 53: Development of portfolio companies’ growth rates________________ 191
Figure 54: Development of portfolio companies’ valuation __________________ 191
XVI
Figure 55: Development of portfolio companies’ multiples __________________ 192
corporate governance quality and firm value_____________________ 197
XVII
Tables
Table 1: Questions by areas __________________________________________ 130
Table 2: Original sample of survey by nation ____________________________ 135
Table 3: Statistical results for the hypotheses H1.1–H1.1.7__________________ 158
Table 4: Statistical results for the hypotheses H1.2–H1.2.1__________________ 159
Table 5: Statistical results for the hypotheses H1.2.2–H1.2.3 ________________ 161
Table 6: Statistical results for the hypotheses H1.3–1.3.2 (mixed models
technique)_________________________________________________ 162
Table 7: Statistical results for the hypothesis H1.3.1 (logistic regression
technique)_________________________________________________ 162
Table 8: Statistical results for the hypothesis H1.4 ________________________ 163
Table 9: Results for hypothesis H.2 ____________________________________ 169
Table 10: Statistical results for hypotheses H2.1–H2.1.4 (mixed models) _______ 170
Table 11: Statistical results for hypotheses H2.1.1 (logistic regression) _________ 170
Table 12: Statistical results for the hypothesis H2.2 ________________________ 171
Table 13: Statistical results for hypotheses H2.3–H2.3.3 (mixed models) _______ 171
Table 14: Statistical results for hypotheses H2.3.1–H2.3.2 (logistic regression)___ 172
Table 15: Statistical results for hypotheses H2.4–H2.4.2 ____________________ 173
Table 16: Statistical results for hypotheses H2.5–2.5.3 ______________________ 174
Table 17: Statistical results for hypotheses H2.6–2.6.4 ______________________ 174
Table 18: Statistical results for hypothesis H3 _____________________________ 178
Table 21: Statistical results for hypothesis H3.2.2 __________________________ 182
Table 22: Statistical results for hypotheses H3.2.3–H3.2.4 ___________________ 183
Table 23: Statistical results for hypothesis H3.3 ___________________________ 184
Table 26: Statistical results for hypothesis H3.3.5 __________________________ 187
Table 27: Statistical results for hypothesis H3.4 ___________________________ 188
Table 28: Statistical results for hypothesis 4.1_____________________________ 193
Table 29: Statistical results for hypothesis 4.1.1 ___________________________ 194
XIX
Table 31: Statistical results for hypothesis 4.2_____________________________ 196
XX
Abbreviations
C Measurement by criteria
CEO Chief executive officer
CG Corporate governance
EBITDA Earnings before interest, taxes, depreciation and amortisation
IM Investment manager
IPO Initial public offering
Max Maximum value of all cases
MBI Management buyin
MBO Management buyout
Mean Arithmetic mean
Min Minimum value of all cases
N Number of cases
OECD Organisation for Economic Cooperation and Development
REML Restricted maximum likelihood
ROA Return on assets
ROE Return on equity
S Measurement by self-assessment
Std. Dev. Standard deviation
VC Venture capital
XXI
1 Introduction
This chapter discusses the relevance of venture capital and corporate governance. The
results of the literature review are used to identify the most important aspects of this
topic and to reveal existing knowledge gaps. Based on that, the aims of the thesis and
the corresponding research approach are defined. This determines the structure of the
work, as described in the last paragraph.
1.1 Relevance of the Topic

The relevance of the topic is found in the importance of good corporate governance to
the success of venture capital-financed growth companies and in the importance of
those companies to the economy.
The particular corporate governance — i.e., the framework of management and

control1 — is considered a key advantage but can also be a severe burden for growth
companies. On one hand, the simple structures and processes of founder manager-
focussed corporate governance allow for high flexibility in growth companies. Thus,
the high velocity of the markets is mirrored by fast decision making in the companies.
Small boards get more done, faster. And the high level of managerial ownership seems
to prevent conflicts of interest between owners and managers in these companies. On
the other hand, the simple form of corporate governance brings about disadvantages,
too. Small boards lack diverse viewpoints and relevant experiences in other industries
when decisions are made. Moreover, the strong managerial ownership limits the
oversight of the companies' managers, which further increases their power.2 These
disadvantages contributed to failures of growth companies — in particular at the
height of the New Economy at the turn of the millennium — like EM.TV, Kabel New
Media and Lernout & Hauspie Speech Products. The examples indicate that the
corporate governance systems of growth companies might not effectively protect
shareholders' wealth. Hence, the success of a growth company depends on, among
other things, adequate corporate governance that fosters its advantages but limits the
related risks. Introducing good corporate governance therefore represents a challenge
for growth companies and the venture capitalists that are the first external investors in
many of them. Venture capitalists' primary interest is value creation, so they should
1
Grundsatzkommission Corporate Governance (2000), p. 1; Bassen (2002), p. 20.
2
Langberg (2006).
1
acknowledge the importance of corporate governance and exert adequate influence
accordingly.3
The importance of venture capital-financed companies to the European economy is

significant. In 2005, venture capitalists invested 47 billion Euros in nearly 7.000
private growth companies in Europe. All in all, the venture capital-financed companies
employed about 6 million people, and their employment growth between 2001 and
2004 was 5,4% p.a., seven times higher than the average employment growth rate in
the European Union.4 During the coming years, European venture capitalists plan to
further increase their activities.5
The importance of good corporate governance to the success of growth companies and
of those companies to the economy indicates the high relevance of this thesis. It is
aimed at shedding light on the relationship between venture capital, corporate gover-
nance and the firm value of growth companies. In particular, its aim is to analyse how
venture capitalists influence the development of corporate governance in growth
companies to foster the associated advantages but reduce the related risks. The specific
research questions of the work are derived from a comprehensive literature review.
1.2 Literature Review

In the following paragraph, the most important research about the development of
corporate governance in venture capital-financed companies is summarised. The topic
brings together two distinct research streams: research on venture capital and research
on corporate governance. In relation to this work, the first stream focuses on the influ-
ence that venture capitalists exert on the corporate governance of portfolio companies,
whereas the latter stream mainly deals with the effectiveness of different corporate
governance elements. Hence, the analysis combines two generally separated pers-
pectives. Accordingly, this is mirrored in the review of the most important literature on
the development of corporate governance in venture capital-financed growth
companies.
3
Accordingly, the European Venture Capital Association developed guidelines for venture capitalists'
influence on portfolio companies’ corporate governance in 2005; refer to EVCA (2005c).
4
EVCA (2005a), p. 4.
5
Investments by European venture capitalists are expected to grow from 0,26% of the European Union
gross domestic product in 2004 to about 0,6% in 2007; refer to EVCA (2005b), p. 4.
2
After presenting the foundations of the research, the literature review is structured
along the key aspects of the relationship between venture capital and corporate gover-
nance: the reasons, factors and instruments of the venture capitalists' influence, the
effects of the influence on corporate governance elements, and the effects of good
corporate governance on firm value. Taking into account the different functions of cor-
porate governance, the review distinguishes between the longer established control
function and the only recently researched advice function.
1.2.1 Foundations of Research on Venture Capital and Corporate

Governance
Firstly, the most influential research on the control function of corporate governance in
venture capital finance is introduced before the evolving work on the advice function
is presented.
BERLE/MEANS6 first defined corporate governance in 1932 against the background

of conflicts of interest between shareholders and managers of companies. This agency
relationship is most dominantly concretised by JENSEN/MECKLING7, JENSEN8 and
SHLEIFER/VISHNY,9 who focus only on the control function of good corporate
governance that should reduce agency costs. On this basis, SAHLMAN10 applied the
corporate governance mechanisms to venture capital. His research on the structure and
governance of venture capital organizations provided the basis for a great part of
subsequent work. From an agency-perspective, he describes the structures used to
govern the uncertainty and information asymmetries in the two interrelated relation-
ships, the one between the investor and the venture capitalist and the other between the
venture capitalist and the portfolio company. For the latter relationship, negotiating
comprehensive rights for the venture capitalists in the contracting phase and struc-
turing the financing and active involvement of the venture capitalists in portfolio
companies are considered most important. This comprehensive description again laid
the basis for more detailed analyses on different aspects of the topic. GOMPERS11 and
LERNER12 researched how venture capitalists use corporate governance elements to
6
Berle/Means (1932).
7
ensen/Meckling (1976).
8
Jensen (1986).
9
Shleifer/Vishny (1989).
10
Sahlman (1990).
11
Gompers (1995), Gompers/Lerner (1996), Gompers/Lerner (1999).
12
Lerner (1994), Lerner (1995).
3
reduce investment risk. KAPLAN/STRÖMBERG13 and SAPIENZA ET AL.14 consider
improvement of the control function of corporate governance as one of the primary
value-adding roles of venture capitalists, thus neglecting that it can also have an advice
function.
Recently, research appeared that focused on the advice function of corporate

governance, which is mainly derived from the resource-based view and the dynamic
capabilities approach. A significant contribution comes from EISENHARDT,15 who
describes the conditions for good decision making in high-velocity environments and
thereby explains the importance and requirements of good corporate governance.
Later, TEECE ET AL.16 specified the relation between the dynamic capabilities of a
company such as corporate governance, its strategic management, and value creation.
Their research indicates the value-adding role of the advice function of corporate
governance. GABRIELSSON/HUSE17 apply this understanding to venture capital.
They analyse the advantage of advice by qualified non-executive board members to
the managers of venture capital-financed companies. As yet, the advice function of
corporate governance has been analysed in the context of corporate boards only, which
indicates the novelty of this research.
1.2.2 Venture Capitalists' Influence on Corporate Governance

In this section, the most important research on the influence of venture capitalists on
the corporate governance of portfolio companies is presented, in particular analyses of
their reasons, other influencing factors and the instruments they use for the influence.
1.2.2.1 Reasons
Several authors analysed why venture capitalists influence the corporate governance of
portfolio companies. The focus of this research is primarily the relationship between
the associated risk in an investment and the influence of venture capitalists. BARNEY
ET AL. found that the venture capitalists’ level of control depends on the level of
business and agency risk of an investment.18 The subsequent research by FIET
analysed this relationship in more detail and compared venture capitalists and business
13
Kaplan/Strömberg (2004).
14
Sapienza et al. (1996).
15
Eisenhardt (1989).
16
Teece et al. (1997).
17
Gabrielsson/Huse (2002).
4
angels regarding their reactions to market and business risk. According to that
research, venture capitalists invest more in the search for information on the associated
market risk of a potential investor whereas business angels invest more in information
on the associated agency risk. This is explained by the fact that venture capitalists are
specialised in reducing agency risk by improving the corporate governance of their
portfolio companies. When selecting investments, they focus on market risk, and after
the investment is done they utilise safeguards to protect themselves from agency
risks.19 BARNEY ET AL. analysed these contractual safeguards in regard to different
types of opportunism. They differentiated between managerial opportunism that occurs
if managers make decisions in the company that reduce the investor’s wealth, and
competitive opportunism that occurs if they harm the company by leaving the current
firm and starting a new competing firm. They show that venture capitalists take appro-
priate measures against a specific type of opportunism only if the risk is great. That
means venture capitalists take measures to prevent managerial opportunism if there are
obstacles to the monitoring of management’s behaviour, and they take measures
against competitive opportunism if the returns to starting new firms are large.20 These
findings indicate that venture capitalists adapt their influence on the corporate gover-
nance of their portfolio companies according to the associated risk and that, therefore,
the influence might well differ for different portfolio companies of the same venture
capitalist.
These results indicate that the previous research is primarily based on agency theory
and considers risk as the main reason for venture capitalists to influence the corporate
governance of their portfolio companies.21
1.2.2.2 Factors
Apart from the reasons for the influence, the research also looked at different factors
that determine the impact of venture capitalists on corporate governance.
The work of SAPIENZA ET AL. compares venture capitalists’ influence on corporate

governance in four countries and adds further evidence that the level and nature of this
influence differs internationally. The analysis found that the level of involvement of
18
Barney at al. (1989).
19
Fiet (1991); Fiet/Hellriegel (1995); Fiet (1995)
20
Barney et al. (1994).
21
It should be noted that some of the empirical analyses did not find support for this perspective, e.g.:
Fredriksen/Klofsten (2001), pp. 214ff.
5
venture capitalists depends on the origin of the venture capitalist. Thus, venture
capitalists in the United States and the United Kingdom are much more active in their
portfolio companies than those in France and the Netherlands, which might be exem-
plary for continental European markets.22 This finding should be particularly relevant
for research in corporate governance as the experience from different national
corporate governance systems might impact the venture capitalists’ influence.
Apart from that, previous research indicates that the type of venture capitalist might
also affect their policy concerning corporate governance. BEUSELINCK ET AL.23
compared the influence of independent and governmental venture capitalists on the
reporting of their portfolio companies. They found that independent venture capitalists
have a stronger impact on the reporting, for example the reduction of earnings man-
agement, than governmental venture capitalists. Other characteristics that impact
corporate governance include the international activity of venture capitalists24 as well
as characteristics of the investment manager, such as his/her experience and commit-
ment.25 Similarly, characteristics of the investment manager were also found to have a
significant impact on the influence of venture capitalists on their portfolio companies.
DIMOV/SHEPHERD26 researched this in more detail and found that different aspects
of the human capital of the investment managers have an impact on the assistance they
can offer.
1.2.2.3 Instruments
The instruments that venture capitalists use to influence the corporate governance of
their portfolio companies can be grouped into contractual safeguards, monitoring, and
support and have been intensively researched.
Important work on investment contracts was done by, among others,

KAPLAN/STRÖMBERG.27 One basic finding is that venture capitalists allocate cash-
flow and liquidation rights separately from influence rights such board positions,
voting, and control rights and that these are contingent on the performance of the
22
Sapienza et al. (1996).
23
Beuselinck et al. (2004).
24
Van den Berghe/Levrau (2002).
25
Ruppen (2001); Rosenstein et al. (1993); Gorman/Sahlman (1989); Van den Berghe/Levrau (2002).
26
Dimov/Shepherd (2005).
27
Kaplan/Strömberg (2003); Kaplan/Strömberg (2004).
6
portfolio companies. GOMPERS28 and LERNER29 analysed financing instruments
such as staging and syndication, which are used by venture capitalists in combination
with close monitoring to reduce investment risk. They researched under what circum-
stances which instruments are used. VAN DEN BERGHE/LEVRAU30 focus in their
research on the different types of monitoring: shareholder agreements, differentiated
shareholder rights, board membership and relationships with managers. All this work
focuses on the control function that should create value by preventing the managers
from making mistakes. In contrast to this, HELLMANN/PURI31 analyse the support
venture capitalists can provide to professionalize portfolio companies. They help the
companies, for example, improve human resource policies, hire executives, and adopt
stock-option plans. Hence, this support includes corporate governance elements that
might fulfil an advice function.
All in all, these findings show that different venture capitalists might influence
corporate governance in different ways or with different effects based on their charac-
teristics. Consequently, these aspects have to be considered when analysing the impact
of venture capitalists on the development of their portfolio companies' corporate
governance.
1.2.3 Effects of Venture Capitalists' Influence on Corporate

Governance
The research on the effects of venture capitalists’ influence on corporate governance
has concentrated so far mainly on the replacement of managers, the efficiency of
boards, and the quality of reporting information, thus taking into account both the
control and the advice functions of corporate governance.
1.2.3.1 Managers
The analyses of POLLOCK ET AL.32, WASSERMAN33, MARTENS ET AL.34 and
BOEKER/WILTBANK35 all indicate that venture capitalists are a main driver of the
replacement of founder-chief executive officers (CEOs) in growth companies. They
28
Gompers (1995), Gompers/Lerner (1996), Gompers/Lerner (1999).
29
Lerner (1994), Lerner (1995).
30
Van den Berghe/Levrau (2002).
31
Hellmann/Puri (2002).
32
Pollock et al. (2005).
33
Wasserman (2003).
34
Martens et al. (2005).
7
found that founder replacement occurs more often in venture capital-backed
companies than in non-venture capital-backed companies. Thus, venture capitalists
often consider founders incapable of fully developing the portfolio companies’ value
potential. However, this notion is only partially supported by empirical findings. In the
short run, the portfolio companies’ ability to raise capital in initial public offering
(IPO) processes is increased with a professional CEO. But in the long run, the likeli-
hood of delisting is smaller for companies with a founder-CEO compared to those with
a professional CEO.36 This challenges the practice of venture capitalists replacing
founder-CEOs.
1.2.3.2 Boards
A study by FILATOTCHEV ET AL.37 indicates that venture capitalists increase the
independence of the portfolio companies’ boards. They analysed the board structure of
companies at the time of their IPO and found that the number of independent board
members is significantly related to venture capital backing.
ROSENSTEIN38 analysed the effects of venture capitalists on the balance of power in

the boards of growth companies and on formal criteria of board efficiency. Boards in
venture capital-backed companies are described as standing between the two polar
board types of boards in ‘conventional small firms’ and those in large corporations.
Their working style is more formal than in non-venture capital-backed firms, and they
have a collaborative relationship with the managers of the firm. Their involvement in
strategic decision making is, according to this, higher than for the two other board
types. This finding is supported by subsequent research by FRIED ET AL.39 In a later
work, ROSENSTEIN ET AL.40 analysed the value added by venture capitalists on
boards. They found that CEOs of portfolio companies do not generally rate the value
of advice by venture capitalists’ representatives on the board as higher than that of
other members. Though the value added is significantly higher if the invested venture
capitalist is one of the experienced ‘top-20’ venture capital-firms. This indicates that
the ability of venture capitalists is an important factor when analysing the effects of
their influence on corporate governance. The effectiveness of venture capitalists as
35
Boeker/Wiltbank (2005).
36
Pollock et al. (2005).
37
Filatotchev et al. (2005).
38
Rosenstein (1988).
39
Fried et al. (1998).
40
Rosenstein et al. (1993).
8
monitors of companies is underlined by the results of LERNER’s41 research. He
found that venture capitalists’ representation on a board increases around the time of
CEO turnover. In contrast to this, the number of other outsiders on the boards remains
constant.
1.2.3.3 Reporting Discipline

As yet, there are only a few findings on the effects of venture capitalists’ influence on
the reporting discipline of portfolio companies. It was shown that venture capital-
backed companies have higher discretionary accruals than non-venture capital-backed
companies before an investment is done.42 BEUSELINCK ET AL.43 provide empirical
evidence that the influence of venture capitalists leads to a reduction of these discre-
tional accruals and to a faster reporting of losses than found in non-venture capital-
backed companies. This indicates a positive effect of venture capitalists’ influence.
These findings indicate that venture capitalists influence portfolio companies to

improve corporate governance: On one hand, they strengthen the control function by
replacing managers, if required, increasing the independence of boards and improving
reporting discipline. On the other hand, they also improve the advice function of
corporate governance by increasing the boards' abilities to make strategic decisions.
1.2.4 Effects of Corporate Governance on Firm Value

Venture capitalists’ influence should increase firm value, which is the primary goal of
the investors. The following presents the findings of previous research on the effects of
good corporate governance on firm value. These analyses focus primarily on the
control function of corporate governance.
Several studies looked at the relationship between good corporate governance and firm
value. The findings of GOMPERS ET AL.44 indicate that companies with good corpo-
rate governance have better performance than companies with bad corporate
governance. They analysed the corporate governance of American listed companies
and found a significant relationship between corporate governance quality and perfor-
mance measures such as share price return, Tobin’s Q and earnings per share.
41
Lerner (1995).
42
Beuselinck et al. (2004), Hochberg (2002).
43
Beuselinck et al. (2004).
44
Gompers et al. (2003).
9
BROWN/CAYLOR45 found a positive relationship between corporate governance and
the fundamental performance of listed companies, measured by return on equity
(ROE) and return on assets (ROA). Several other studies support these findings. All
research in this area has been done exclusively using empirical analyses of listed
companies.
In regard to younger companies that are not yet at the point of an IPO, the knowledge
on the relationship between good corporate governance and firm value is limited.
DAILY/DALTON46 analysed the relationship between governance structure and the
performance of entrepreneurial companies. They looked at the effects of board
structures, more particularly at CEO duality and the number and proportion of
outsiders on the boards. The study indicates modest positive effects of board
independence on firm performance.
This shows that corporate governance research is much more advanced for public
companies than it is for young private companies. Furthermore, corporate governance
elements relating to the advice function have largely been neglected so far.
Nonetheless, a positive value effect of good corporate governance should be expected
if the findings for public companies can be applied to growth companies.
1.3 Aims of the Research

The literature review lays a profound basis for this thesis, but it also reveals
knowledge gaps in the research on venture capital and corporate governance. This is,
on one hand, due to the novelty of the research area and is due, on the other hand, to
the fact that the topic brings together two generally separated streams of research. In a
nutshell, there are five shortfalls of previous research that should be addressed here.
The research on venture capital has in the past focussed mainly on single corporate
governance elements but neglected to give a comprehensive picture of the corporate
governance system of a company and its development. Thereby, the research was built
mostly on agency theory and therefore concentrated on the monitoring and bonding
functions but neglected the advice function of corporate governance. Furthermore,
it often falls short of connecting corporate governance to firm value, which is
actually in the centre of venture capitalists' interest. In contrast to this, traditional
corporate governance research analysed this relationship intensively. But it has taken
45
Brown/Caylor (2004).
10
into account only well-established public companies, which should already have well-
developed corporate governance systems. This stream almost entirely neglected the
development of corporate governance in young companies, where greater
differences in quality should exist. Moreover, the analyses are almost entirely static
because they neglected developments of corporate governance and firm value,
which leads to a problem of endogeneity.47 Hence, the primary aim of this work is to
combine the perspectives of these two distinct streams of research and to analyse the
development of corporate governance in growth companies and its effects on firm
value. More precisely, this thesis should contribute to narrowing the knowledge gap
and smoothing methodological limitations by answering two research questions.
First, the research will build on previous findings on the influence of venture
capitalists on the corporate governance of portfolio companies. Venture capitalists, as
the first external shareholders of growth companies, could be a main force behind the
development of corporate governance from the foundation of companies to their going
public48 when a sophisticated corporate governance system is mandatory. Thus, corpo-
rate governance research at the level of growth companies enables tracking of the
professionalisation of the companies' management and control systems. Analysing the
influence of venture capitalists on this development requires an understanding of the
reasons and the factors of this influence as well as its outcome. Growth companies are
characterised by high risks and great potentials but limited resources. And venture
capitalists do not only create value by minimising risk but also by adding value in
form of support. This requires the research to focus not only on the control function of
corporate governance but also on its advice function.49 Furthermore, the interrelation-
ship of corporate governance elements must be considered when corporate governance
is analysed.50 Accordingly, this research will draw a comprehensive picture including
all relevant elements related to the managers, the boards and the reporting of
companies. Moreover, the analysis of corporate governance in growth companies and
the influence of venture capitalists requires a dynamic research design, which has not
often been used in venture capital or in corporate governance research. A longitudinal
analysis should deliver valuable knowledge on the development of growth companies.
46
Daily/Dalton (1992), pp. 380 ff.
47
For an explanation refer to 6.2.1.
48
While the strongest development should be noticed for a company that goes public, this holds also for
other changes of ownership such as mergers and acquisitions by strategic investors.
49
50
Rediker/Seth (1995).
11
Thus, the first broad research question of this thesis is: How do venture capitalists
influence the corporate governance of portfolio companies throughout their
development? It thereby incorporates several aspects of venture capitalists’ influence
and the corporate governance of growth companies in a dynamic analysis. Building on
the findings from the literature review, three aspects are analysed: The reasons venture
capitalists influence portfolio companies' corporate governance are analysed first.
Then the impact of their influence on different corporate governance elements is
researched. Finally, the abilities of venture capitalists are incorporated in the analysis,
too, as the impact on corporate governance might not only be determined by the
strength of the influence.
Second, the analysis should also help to narrow the knowledge gap related to the
effects of corporate governance on firm value. This is closely connected to the first
research question because the primary goal of venture capitalists is generally value
creation, which means that the influence of venture capitalists on the corporate
governance of portfolio companies should be motivated by expected effects on firm
value. This relation has so far been researched only for public companies, but it is
equally important for growth companies. In particular, greater effects could be expec-
ted because corporate governance should differ more significantly for the latter. In
contrast to earlier research, where perceived value creation was analysed, this thesis
centres on financial firm value, corresponding to corporate governance research for
public companies. It should thereby take into account a comprehensive picture of the
corporate governance of growth companies and their fundamental performance as well
as investors' valuation. Hence, the second research question of this work is: What are
the effects of good corporate governance on the firm value of growth companies?
1.4 Research Approach

The research concept was adapted to the research questions and methodological
challenges51. It was developed with valuable support from Sophie Manigart and
Lutgart van den Berghe from Vlerick Leuven Gent Management School as well as
Mike Wright from the University of Nottingham. The research concept comprises both
theoretical and empirical analyses. Whereas the theoretical analysis is done to build an
understanding of the relationships between venture capital, corporate governance and
51
For a review of methods used in entrepreneurship research, refer to Shane/Venkataraman (2000), pp.
217ff.
12
firm value and to derive corresponding hypotheses, the empirical analyses verify the
hypotheses in practice. In order to ensure a comprehensive framework of the imma-
nent relationships, the analysis is based on economic and managerial theories.52 They
have different foci and might therefore lead to different hypotheses. Because of their
particular suitability to mirror the monitoring and bonding function as well as the
advice function of corporate governance, the agency theory and the dynamic resource-
based view were selected for this research. In a second step, the derived hypotheses are
tested for empirical support. It is intended to gain generalisable results on the develop-
ment of the corporate governance of growth companies and its impact on firm value.
The research comprises qualitative and quantitative analyses in order to prevent single-
method bias. First, semi-structured interviews were conducted with venture capitalists,
managers of portfolio companies and other experts to ensure a profound understanding
of the practice. Heterogeneous cases were selected for the interviews to gain a broad
perspective from different settings. This should allow comparing the hypotheses
derived from theory with common practice in multiple settings. The results of the
qualitative analysis were used to design a questionnaire used for the quantitative
analysis. A pan-European survey of portfolio companies was carried out to represen-
tatively test the hypotheses. CEOs from venture capital-backed companies were
surveyed on the corporate governance of their companies, the influence of their
venture capitalists and the firm value. In contrast to other studies that collected data
from venture capital investment managers, it is expected that this method of data
collection will lead to a more objective judgement on the venture capitalists’
involvement.53 A survey allows for a great number of analysed cases and provides
generalisable results. In the survey, longitudinal data are collected to track the
development of corporate governance. The questionnaire of the survey asks for
retrospective information on the companies' situation at different measuring times.
Key factors for the research design are reliability and validity. The design of this work
was adapted to fulfil the requirements of both as the following indicates. Reliability
means the extent to which a measure yields the same result on repeated trials.54 For a
high reliability, the sample of the quantitative empirical analysis must correspond to
the population of the research. In this case, the total population is all the venture
capital-financed growth companies in Europe. Several checks were done to ensure the
52
Combs/Ketchen (1999), pp. 867ff.
53
For further explanations refer to Shepherd (1997).
54
Carmines/Zeller (1980), pp. 11ff.
13
most complete sample possible was used. It was found that the Thomson Financial
VentureXpert database provides a very good basis as it includes the largest number of
companies of this population. Feedback from selected venture capitalists on their
current portfolio companies indicated that only very few portfolio companies were not
included in the sample. Hence, it can be expected that the sample of the survey
corresponds to a great extent to the population of the research.
Validity is the degree to which an analysis accurately assesses the specific concept that
should be measured. Internal validity — i.e., the rigour of the analysis — and external
validity — i.e., the generalisability of the results — are to be distinguished. The
internal validity was ensured in this research by several measures. First, the results
were triangulated by qualitative and quantitative research. The findings of the
interviews were used to adapt the questionnaire to the practice so that the questions
correspond well to the concepts that should be assessed. In a further step, a pre-test of
the questionnaire with managers of portfolio companies was done to ensure that the
questions are well understood by the respondents. The survey provided very rich data
due to a comparatively comprehensive questionnaire that takes into account different
forms of measurement (e.g., measurement by self-assessment and criteria) and
different measuring times. For most of the constructs, indexes of several variables
were built in order to further increase the internal validity.55 External validity was
ensured by taking a European perspective that encompasses different economic
regions and different corporate governance systems. Representativeness tests were
conducted for the results of the survey to find out whether the group of respondents
correspond to the sample of the analysis. The test supports representativeness in regard
to the regional distribution but not in regard to the age distribution.56 This might be
explained by the fact that some of the companies in the sample might not have existed
anymore at the time of the survey. Nonetheless, this finding limits the represen-
tativeness of the analysis only a little because of the presumed explanation.
The design of this research is characterised mainly by four particularities. First, it

encompasses integrated theoretical and empirical analyses to build a theory-based
understanding of the relationships between venture capital, corporate governance and
firm value and to verify them in practice. Second, economic and managerial theories
are jointly used as an underlying framework to ensure that the monitoring, bonding
55
Bortz/Döring (1995), pp. 52ff.; Krosnick/Fabrigar (1997), pp. 141ff.
56
For more information refer to 5.3.4.
14
and advice functions of corporate governance are well captured. Third, the empirical
analysis uses a qualitative and a quantitative approach in order to increase the validity
of the findings. Fourth, the analyses are dynamic because they track the development
of corporate governance over time, which is necessary due to the high rate of change
in growth companies and the endogeneity of corporate governance.
1.5 Structure of the Research

The structure of the research results from the research questions with the aspects
derived from the literature review on one hand and from the selected research
approach on the other hand. The thesis is composed of six chapters whose structure is
presented in Figure 1 and detailed in the following.
1 2 3
Agency theory
Venture capital
Aims and approach of
Introduction the research Dynamic resource-
Corporate governance
based view
4
Reasons for Effects of Abilities of Effects of
Theoretical venture venture venture corporate
Analysis capitalists' capitalists' capitalists to governance on
influence influence exert influence firm value
5
Reasons for Effects of Abilities of Effects of
Empirical venture venture venture corporate
Analysis capitalists' capitalists' capitalists to governance on
influence influence exert influence firm value
Conclusion Summary of results Discussion Outlook
Figure 1: Structure of the thesis
This introductory chapter defines the research concept of the thesis. The research
questions are derived from a literature review that reveals the knowledge gaps about
the relationship of venture capital, corporate governance and firm value. They deter-
mine the aims and the approach of the research that are introduced thereafter.
The second chapter builds the basis for the analyses by defining and introducing the
two main concepts of the research. First, the main characteristics of venture capital are
described before the venture capital value chain is detailed. As the introduction
indicated, the venture capital industry develops cyclically from booms to downturns.
This is explained in the historic and recent context. Corporate governance is presented
with a comparison of different definitions and a description of its main elements.
15
Thereafter, the elements are grouped according to their functions: monitoring, bonding
and advice. To conclude, the different groups that influence corporate governance and
their instruments are briefly described, indicating the relevance of venture capitalists to
the development of corporate governance in growth companies.
In chapter three, the two underlying theories are introduced as a basis for the theore-
tical analysis. The origination and main assumptions of the agency theory and the
dynamic resource-based view are illustrated first. Then, the two theories are applied to
the topic by explaining the theories' understanding of corporate governance and their
perspective on the importance of corporate governance for growth companies.
The next chapter contains the theoretical analysis of the relationship between venture
capital, corporate governance and firm value that provides theory-based hypotheses. It
starts with the theories' distinct perspectives on the reasons for venture capitalists to
influence the corporate governance before the effects of the influence on the different
elements are described. Thereafter, the venture capitalists' abilities that are expected to
impact the corporate governance of the portfolio companies are analysed, in particular
the venture capitalists' control rights, the characteristics of the venture capital firms,
and those of the investment managers. In the end, it is analysed what effects corporate
governance quality should have on firm value in terms of fundamental performance
and valuation.
The structure of the theoretical analysis is mirrored in chapter six, which presents the
results of the two empirical analyses. Whereas the results of the interviews are
summarised according to the two research questions, the quantitative results are
structured according to the four aspects of the theoretic analysis. The sample and
methods are detailed before the results of the statistical analyses are presented. Uni-
and multivariate analyses are carried out for the venture capitalists' reasons to influ-
ence corporate governance, the effects of the influence, the impact of the venture
capitalists' abilities and the effects of good corporate governance on firm value.
The last chapter summarises and concludes the thesis. The main results of the theore-
tical and empirical analyses are recapitulated and then discussed. The limitations are
explained, and the results are interpreted against the background of earlier findings and
in regard to the different analyses. Finally, the knowledge gaps that the research
revealed are detailed in order to propose future analyses.
16
2 Foundations of Venture Capital and Corporate
Governance
This chapter lays the foundations of the work by introducing venture capital and
corporate governance. The description of venture capital includes the characteristics of
venture capitalists and the actions they take to pursue their goals. It then details the
corporate governance elements and their functions as well as how stakeholders can
influence those elements. This is the basis for understanding the succeeding chapters.
2.1 Introduction of Venture Capital

This chapter introduces venture capital with a definition and a description of the main
characteristics. It then details the different steps of the venture capital value chain
before the development of the industry is presented.
2.1.1 Definition
The term “venture capital” is not well defined in the literature, in particular in different
regions of the world.57 There are different definitions but also cognate terms that have
partially intersecting meanings. The reason for this is that the term was coined by
practice and not the outcome of a theoretical construction.58
Generally, venture capital is an equity or equity-related financing form for growth

companies.59 In Europe, financing growth in younger companies is called venture
capital, whereas financing buy-outs of established companies is called private equity.
In contrast to this, in America both forms of financing are considered either venture
capital or private equity.60 Both definitions have in common that only private compa-
nies are financed and that the investment is limited with the goal of realizing financial
return. In this work, the broader American perspective is used. Characteristically,
venture capital is not only the provision of financing to growth companies but includes
also non-financial support for the companies. This is aimed at reducing the investment
57
Bader (1996), p. 4; Schefczyk (2000), p. 15.
58
Bader (1996), pp. 4ff.
59
Bader (1996), p. 10; Schefczyk (2000), p. 18.
60
Kraft (2000), pp. 31ff.; Sahlman (1990), p. 479, EVCA (2004), pp. 2ff.; Bader (1996), pp. 4ff.
17
risk and fostering the companies’ development.61 The following definition is used in
this work:
Venture capital is an equity or equity-related financing form for private growth

companies for a limited time, including non-financial support for the company.
2.1.2 Characteristics
The definition introduces four characteristic attributes.
Equity or equity-related financing

Venture capital is generally financing with equity character, which give the
investors considerable information and control rights.62 Often, investors prefer
mezzanine instruments that are similar to equity, such as convertible debt or
dormant participation, to reduce the associated risk.63
Medium-term investments
Venture capital is provided for a limited investment horizon with the aim of
generating financial return.64 Investors sell their shares in the companies after two
to ten years — depending on the development of the portfolio companies — in
order to realise their goal.65 Because of the associated high investment risk,
investors expect a relatively high return of 25–45% p.a., depending on the
development stage of the investment.66
Concentration on growth companies

The prospect of such a high return is found only among companies with
corresponding growth potential67. Therefore, venture capitalists invest only in
growth companies. The growth potential of younger companies68 lies in the market
61
Schefczyk (2000), pp. 41ff.
62
Ruppen (2001), pp. 200ff.
63
Kaplan/Strömberg (2003), S: 286; Sahlman (1990).
64
Ruppen (2001), p. 21; Bader (1996), p. 14.
65
Bader (1996), p. 14.
66
Manigart et al. (2002), p. 302, Schefczyk (2000), p. 18; Bygrave et al. (1989), pp. 98ff.; Zider (1998), pp.
135 ff.
67
Growth in this context means economic growth related to the growth of measures such as sales, earnings,
employees, share price and return on investment; to be a growth company the growth rate must be
comparatively higher than the average growth of the gross domestic product, but a definite threshold
cannot be given, cf. Kock (2002), pp. 660ff.
68
Growth companies can also include management buyins and management buyouts where the financed
company is generally also a relatively new entity even if its origins are in an older company. The
ownership and management structures are still new in these cases. They are included in the empirical
18
entry and expansion.69 In those companies, management often includes the
founders of the company who also own the company. This can lead to information
asymmetries and conflicts of interest between the old and new shareholders.70 The
managers of these companies possess only limited management experience, and the
realization of the companies’ growth makes high and changing demands on their
management qualities. Furthermore, changes inside the companies, as well as in
supply and product markets, also increase the investment risk. This stresses the
companies’ need for external management support.71 In order to realise their
growth potential, the companies have great capital and support requirements, but
because of the associated high risks they have only limited financing possibilities.72
Active investors
Venture capital investors are active investors, on one hand because of the high
support demand of the managers of growth companies and on the over hand
because of the high investment risk. The investment risk of venture capital arises
for three reasons: the conflicts of interest between the investors and the managers
of the companies, the additional conflicts of interest between the outside investors
and the founders as inside investors, and the particular risks that result from the
high growth of companies.73 Therefore, the investors influence portfolio companies
before (ex-ante) and after (ex-post) the investment is done. Before the investment,
investors can negotiate contractual agreements that limit the managers’ scope to
give them an incentive to foster the companies’ development (bonding). Ex-post,
the investors can introduce further contractual agreements and use monitoring to
supervise the companies and their managers.74 This influence is in great part related
to the corporate governance of portfolio companies.75 Figure 2 gives an overview of
the investors’ possibilities for influencing the portfolio companies. Those
possibilities are detailed in the following chapters.
analyes but have a relatively limited influence due to the small number of later stage companies in the
sample and the group of respondents.
69
Kraft (2001), pp. 43ff.; Fenn et al. (1997), pp. 27ff.
70
Schefczyk (2000), p. 18; Roberts (1991), pp. 9ff.
71
Ruppen (2001), p. 28.
72
Ruppen (2001), pp. 27ff.; Berger/Udell (1998), pp. 622ff.; for a theoretical analysis refer to Ueda (2004),
pp. 601ff.
73
Lerner (1995), pp. 301ff.; Sapienza et al. (1996), pp. 443ff; Ruppen (2001), p. 28ff.; Gorman/Sahlman
(1989), pp. 236ff.; Ruhnka/Young (1991), pp. 116ff.
74
Amit et al. (1998), pp. 441ff.; Coopey (2003), p. 150.; Wang/Zhou (2004), pp. 131ff.; Kaplan/Strömberg
(2001), pp. 426ff.
75
For more information of the venture capitalists' influence on the corporate governance refer to Aoki
(1999), pp. 1ff.
19
Shareholder agreements
Change of Articles of
Portfolio Company
Association
Venture Capitalist
Change of portfolio company‘s
contracts (e.g., employment
contracts)
Reporting
Board membership
Cooperation with the

managers
Figure 2: Influence of venture capitalists on portfolio companies
2.1.3 The Venture Capital Value Chain

The value creation of venture capitalism originates from the coactions of three groups:
the investors who provide capital for investments, the venture capitalists who collect
capital and invest it, and the portfolio companies that use the investments for their
development.76
Figure 3 shows the value chain with its three layers in a simplified form.77
Investments in
Investors
venture capital
Venture capitalists Fundraising Investment Exit
Portfolio companies Start-up Growth Newly quoted
Figure 3: Venture capital value chain78
76
Gifford (1997), pp. 460.
77
It should be noted that for the level of the investor and the portfolio company only the steps of the value
chain that are relevant for the venture capital investment are illustrated. They also have a value chain on a
higher level for the realisation of their own business.
20
2.1.3.1 Fundraising
First, the venture capitalists must raise the capital for investments during a fundraising
phase. Normally, the venture capitalists collect capital from several investors to fina-
nce a fund that is invested in a portfolio of companies.79 Conflicts of interest might
also occur between the investor and the managers of the venture capital firm, so
several instruments are used during the contracting phase to reduce that risk. The in-
vestment managers are limited in their decisions by contractual agreements called
covenants that, for example, require the managers to diversify the portfolio.80 Apart
from that, the compensation of the investment managers depends on the success of the
investments in order to diminish possible conflicts of interest between the investors
and the venture capitalist.81
There are five groups of investors to distinguish:
Institutions
Institutional investors, such as pension funds, insurance companies and banks,
supply the greatest part of the funds. They use venture capital investments as a
supplement to their portfolios. Apart from the effects of diversification, the high
rate of return of venture capital increases the average return of their portfolios.
They pursue only financial goals.82
Public authorities
Public authorities invest in venture capital because of the importance of growth
companies for economic development. Apart from public subsidy programmes,
several governmental institutions supply funds for investment in growth compa-
nies.83
78
Based on Achleitner (2002), pp. 142ff.
79
Exceptions are listed venture capitalist firms such as TFG AG 3i Group PLC that invest equity that they
received through the capital markets. Additionally, corporate venture capitalists and governmental
venture capital investors do not have to externally raise funds as they are generally funded internally. For
more information on the organisational arrangements of investments in venture capital funds refer to e.g.
Schefczyk (2001), pp. 55ff.; Lerner/Gompers (2002), pp. 29ff.; Callison (2000), pp. 97ff.; for more
information on the determinants of venture capital funding refer to Jeng/Wells (2000), pp. 241ff.; for
more information on the portfolio designs of venture capitalists refer to Kanniainen/Keuschnigg (2003),
pp. 521ff.
80
Refer for comprehensive information to e.g. Gompers/Lerner (1996), pp. 463 ff; Feinendegen et al.
(2003), pp. 1170ff.; Schmidt/Wahrenburg (2003), pp. 4ff.
81
Refer for comprehensive information to Gompers/Lerner (1999), pp. 3ff.
82
Heim (2001), pp. 487ff.; Fleischhauer./Hoyer (2004), pp. 395ff.
83
Refer for comprehensive information to Leleux/Surlemont (2003), pp. 81ff.
21
Companies
Established companies supply capital generally for investments in growth
companies of related industries to pursue strategic goals rather than financial goals.
These goals include the revitalisation of the company’s culture, access to new tech-
nologies and in some cases even ensuring the livelihood of the company. This
special type of venture capital is called corporate venture capital.84
Private individuals
There are only few private investors in venture capital.85 The reasons for this are on
one hand the high investment risk and on the other hand the lack of a transparent
market for venture capital investments.86 Normally they pursue only financial
goals.87 A special group of private investors are business angels who invest directly
in growth companies without the mediation of venture capital companies. In many
cases, they are active or past entrepreneurs themselves who invest both their capital
and their personal know-how. They sometimes combine financial goals with
personal ones.88
Fund-of-Fund
Apart from the investors that provide capital to venture capitalists, there are also
fund-of-fund investors that collect capital from investors to invest it in several ven-
ture capital funds.89 They represent a second intermediary between the capital
provider and the growth company.
Figure 4 shows the proportions of the five investor types for the invested capital in
Europe in 2005.
84
Sykes (1990), pp. 37ff.; Winters/Murfin (1988), pp. 207ff.; Zahra (1991), pp. 259ff.; Sykes/Block (1989),
pp. 159ff.; for a theoretical analysis of the advantages and disadvantages of strategic investments by
companies, refer to Hellmann (2002), pp. 285ff.
85
Exceptions are labour sponsored venture capital funds in Canada; for more information refer to
Cumming/MacIntosh (2002), pp. 1ff.
86
Exceptions are the public venture capital firms.
87
Brinkrolf (2002), pp. 18ff.; Schefczyk (2000), p. 31.
88
Lerner (1998), pp. 773ff.; Landström (1993), pp. 525ff.; Freear et al. (1994),pp. 112ff.; Wetzel (1987),
pp. 299ff.
89
Kraft (2001), p. 38, Gompers/Lerner (2002), p. 20.
22
Others
10%
Funds-of-
Funds Institutionals
13% 54%
Public
Authorities
12%
Private
Individuals
6% Companies
5%
Figure 4: Newly invested capital in Europe 2005 by investor type90
2.1.3.2 Deal Sourcing and Screening

Apart from the fundraising, a sufficient deal flow is also of crucial importance for
venture capitalists’ success, in particular because of the low rate of potential
investments among the investment proposals.91 The acquisition of proposals is done
through different channels, for example over the network of the venture capitalists,
participation in conferences or membership in industry associations.92 When selecting
potential investments, the focus is first on the fit to the venture capital firm and the
specific fund. Often, venture capitalists concentrate their investments on companies in
a specific development phase, a specific industry or a specific region.93 That enables
them on one hand to better select and support portfolio companies because of their
specialised knowledge and on the other hand to take advantage of synergies between
several portfolio companies.94
Figure 5 shows the typical development of growth companies and the corresponding
financing phases, which are described next. 95
90
Own illustration based on EVCA (2005).
91
Generally, venture capitalists invest only in one or two out of 100 proposals, Zemke (1995), p. 211.
92
Brinkrolf (2002), p. 28; Schefczyk (2001), p. 34, Fiet (1995), pp. 198ff.
93
Elango et al. (1995), pp. 166ff.; Gupta/Sapienza (1992), pp. 347ff.; Robinson (1987), pp. 63ff.
94
Weber (2002), pp. 107ff.
95
Sahlman (1990), p. 479; Schefczyk (2000), pp. 35ff.
23
Financing Phase
Early Stage Expansion Stage Late Stage
Seed Start-up Expansion Bridge MBO/MBI
Development • Formation of a • Formation of a • Start of • Preparation of • Take-over by

phase company company marketing a) Initial publich esting (MBO) or
• Readiness for • Readiness for • Market entry or offering external (MBI)
start of start of expansion or management
production production financing b) Sale to
• Marketing • Marketing strategic investor
concept concept
Expected
profit/loss of the
portfolio
comapany
Typical financial Own funds Debt financing

sources
Public subsidies Stock Exchange
Venture Capital Private Equity
Figure 5: Development phases of growth companies96
Seed
In this phase, the entrepreneur requires capital to develop a business plan and a
prototype before the company is founded.
Start-up
The capital need in this phase results from the expenditures that occur because of
the founding of the company and product development. Additional costs arise for
first marketing measures that prepare for the market launch.
Expansion
The market entry of the company generally leads to growing capital needs because
the production capacities and the distribution channels must be expanded and
because there are greater expenditures for marketing now.
Bridge-Financing
Before an IPO of the company or a sale to new investors, companies often need
bridge financing because the preparations for such a transaction are costly.
Management Buyout/Buyin
Investors enable internal or external managers to take over a company or a business
96
Based on Schefczyk (2000), p. 37.
24
unit that is then managed independently. Venture capitalists97 or private equity
investors enable the acquisition of the company from its old owners.
After a successful formal screening (if the investment fits the venture capitalist), a
detailed and normally multistage screening is done. The investment decision is largely
dependent on the expected return.98 Strategic investors also include expected non-
financial utility as a further factor.99 Several criteria are analysed during the screening,
on which all venture capitalists decide themselves. The following categories are gene-
rally considered to be the most important:100
Competence and experience of the managers
Personality of the managers
Characteristics of the market
Characteristics of the product
Financial plans.
2.1.3.3 Contracting
After a successful screening of the proposal, venture capitalists start negotiating a
contract with the managers.101 This phase concentrates on the valuation of the
company, the share that the venture capitalist takes over, the financing instrument and
its cashflow, and decision rights as well as changes to the company’s articles and other
contracts.102 During the structuring of the financing, two instruments are used to reduce
risk: In many cases venture capitalists invest together with other venture capitalists in
a syndicate to share the invested capital and the associated risk.103 Moreover,
97
In this case, they are often called private equity investors in order to distinguish late stage and early stage
investors.
98
Schefzcyk (2001), p. 38; for a study on indicators for the expected return refer to Jain (2001), pp. 223ff.;
Brush/Vanderwerf(1992), pp. 157ff.
99
Winters/Murfin (1988), pp. 210ff.; Witt/Brachtendorf (2002), pp. 682ff.
100
Schefczyk (2001), p. 39; Brettel (2002), pp. 309ff.; Macmillan et al. (1987), pp. 125ff.; Eisele et al.
(2003), pp. 406ff.; Zacharakis/Shepherd (2005), pp. 674ff.; Baum/Silverman (2004), pp. 411ff.; Franke et
al. (2002), pp. 654ff.; Fried/Hisrich (1994), pp. 28 ff.
101
For theoretical analyses of contracting refer to Hellmann (1998), pp. 57ff.; Bowden (1994),
Bergemann/Hege (1998), pp. 703ff.
102
Weber (2002), pp. 96ff.; Sahlman (1990), p. 505; Gompers/Lerner (1996), pp. 483ff.; Admati/Pfleider
(1994), pp. 394ff.
103
Lerner (1998), pp. 16ff.; Bygrave (1987), pp. 139ff.; Manigart et al. (2002), pp. 3ff.
25
investments are often not paid out fully in the beginning but in stages as specific
milestones are achieved (staging).104
Apart from the structuring of the investment, venture capitalists also negotiate
covenants that limit the scope of the portfolio companies’ management as well as other
control and decision rights that give the venture capitalist the ability to reduce its
investment risk.105 During contracting, the companies’ articles and other contracts are
also screened, and changes might be negotiated in order to align the interests of the
venture capitalist, the company and its other shareholders.106
2.1.3.4 Venture Management

After closing the investment contract, the first tranche of the committed capital is paid
out, and the continuous support of the portfolio company by the venture capitalists
begins. The goal of the venture management is reducing the associated risk and
increasing the return on the investment.107 Generally, the support of venture capitalists
can be divided into control and support of the portfolio company. The nature of the
control and support depends on several factors such as the characteristics of the
portfolio company and the profile of the venture capitalist. Among others, the develop-
ment phase of the portfolio company is an important factor because companies in the
seed-phase require different support than companies in a later stage. The emphasis of
the required support often changes from more operational questions to strategic,
financial and organisational questions over the development of a company from foun-
ding to the expansion phase. 108 The control function should reduce the associated risk
by bonding the company and monitoring its development and the decisions of the
managers and thereby increase the probability of success and the value of the invest-
ment.109 This is done, for example, by membership on the board and the requirement of
regular reporting by the portfolio company on its financial and strategic develop-
ment.110 Besides this, the support function should further strengthen the portfolio
104
Gompers (1995), pp. 1475ff.
105
Weber (2002), pp. 92ff.; Baums/Müller (2002), pp. 401ff.; Sahlman (1990), pp. 489ff.; Hommel et al.
(2003), pp. 327ff.; for a theoretical analysis of the distribution of control between venture capitalists and
managers of portfolio companies refer to Yerramilli (2004), pp. 1ff.
106
Kaplan/Strömberg (2003), pp. 293ff.; Triantis (2001), pp. 305ff.
107
Sahlman (1990), p. 508.
108
Bader (1996), p. 133; Achleitner/Bassen (2004), p. 162.
109
It should be noticed that control can also lead to disadvantageous effects on performance because of
conflicts with managers; for more information refer to Higashide/Birley (2002), pp. 59ff.
110
Schefczyk (2000), p. 301; Schenk (2003), pp. 403ff.; Lerner (1995), pp. 307ff.; Sapienza et al. (1996), p.
454; Fried et al. (1998), pp. 497ff.; Ehrlich et al. (1994), pp. 74ff.
26
company and thereby increase its value. Therefore, venture capitalists support their
portfolio companies in different areas such as strategic development, the acquisition of
partners and customers, and negotiations with important stakeholders. This is done, for
example, through board membership but also through informal co-operation with
company management.111
One important element of venture management at portfolio companies is the

preparation of the venture capitalists’ exit.
2.1.3.5 Exit
The disinvestment of venture capitalists is done by the sale of their shares. This can be
done either in one step or in several steps. Partial exits are often required, either
because of legal requirements or because of the bad signal that might be associated
with a full exit.112 Because the type of exit the venture capitalist makes has a crucial
impact on the future development of the portfolio company, the exit decision is often a
matter of difficult negotiations between the different shareholders.113
Generally, the following five exit types are possible, but they differ greatly in regard to
their fit for a specific investment at a specific time:114
Buy Back: Sale of the shares to the old shareholder of the company, generally the
entrepreneurs.
Trade Sale: Sale of the shares to a strategic investor, generally an industrial

investor that has an interest in the resources of the portfolio company.
Secondary Purchase: Sale of the shares to a financial investor, e.g., another venture
capitalist.
IPO: Going public of the portfolio company, which is often linked to a capital
increase.
111
Brinkrolf (2002), p. 141.
112
For an empirical analysis of full and partial exits refer to Cumming/MacIntosh (2003), pp. 511ff.
113
Bascha/Walz (2001), pp. 286ff.
114
Schefczyk (2000), pp. 44ff.; Cumming/MacIntosh (2003), pp. 520ff.
27
Liquidation: Withdrawal of the investor by terminating the shareholder agreement
or liquidation of the portfolio company, generally connected with total loss of the
investment.
The decision on the form and time of an exit depends on external conditions such as
the market situation, among other things. In particular, the situation at the stock
exchange has a crucial impact on the possibilities of going public and influences not
just the return of a specific investment but also the development of the entire venture
capital industry.115 That subject is presented in detail in the next chapter.
2.1.4 Development Status of the Venture Capital Industry

As indicated in the very first paragraph, the venture capital industry underwent both a
boom and a decline within the past decade. This shows that the industry's development
is relatively cyclical, which increases the risk of investments. The following presents
the emergence and recent development of venture capital.
2.1.4.1 Emergence of the Industry

Venture capital is still a young form of financing that first developed over several
decades in the USA before investors and companies in Europe used it. The develop-
ment is affected by cycles, in which fast growth and fast downturns alternate.
The first venture capital firm was founded after the end of the Second World War in
Cambridge, Massachusetts. The American Research and Development Corporation
was founded with support from Harvard and MIT universities to provide capital for the
commercialisation of technological developments of the defence industry. The first
fund of this firm was very successful because of the enormous value growth of a few
of its investments.116 In the following decades, the industry grew steadily but slowly.
From 1958 on, there were, besides publicly listed funds for private investors, also new
funds that operated as small business investment corporations, a new type of enterprise
that was created especially for investment firms for small companies. The first strong
increase of cash inflows took place at the end of the 1970s and beginning of the 1980s
as an effect of a legal amendment in 1979. The law of the Employee Retirement
Income Security Act (ERISA) was amended so that pension funds could also invest
115
Gompers (1998), pp. 1089ff.
116
Gompers/Lerner (2002), p. 6; Weber (2002), p. 8.
28
greater parts of their funds in investments with higher risk. The result was that
invested funds of USD 481 millions in 1978 rose to more than USD 5,8 billions in
1986. In the late 1980s, a downturn started because of declining returns on venture
capital investments. The reasons for this were over-investments in some industries and
a growing number of inexperienced employees in venture capital firms due to the rapid
growth of the firms in the years before. Consequently, investments dropped to about
USD 1.600 millions in 1991. In the middle of the 1990s, a strong market for IPOs led
to increased return expectations and a second strong increase in cash inflow.117 At the
height of the new economy, the industry had its peak in 2000 with investments of USD
103 billions.
In Europe, the venture capital industry began to develop several decades after its
beginnings in the USA.118 Even though the first German venture capitalist, Deutsche
Wagnisfinanzierungsgesellschaft, was founded in 1975, the industry developed very
slowly. Only after two decades was there strong growth, parallel to the second boom
phase in the USA.119 The gross investments increased between 1995 and 2000 from
€542 millions to €4.451 millions, which equals a compounded annual growth rate of
52,4%.120 The next section details the development of the industry in Germany since
1995, which shows the huge increase and the even more drastic downturn afterwards.
2.1.4.2 Development of Investments

The funds raised by venture capital and private equity investors grew rapidly in the
late 1990s to a peak of about €47 billion in 2000. Until 2001, the inflow of funds
exceeded the capital in most years. In that year, the new economy had its turning point,
and the funds raised started to strongly decrease thereafter. However, the investments
decreased more slowly than the fundraising so that between 2002 and 2004 invest-
ments exceeded the funds raised. The year 2005 marks a record year: Fundraising
more than doubled compared to the previous year and amounted to almost €72 billion.
As Figure 6 shows, funds raised and investments developed cyclically in the past
decade from growth to decline to growth.
117
Gompers/Lerner (2002), pp. 7ff.; Gompers/Lerner (2001), pp. 146ff.; Kenney (2000), pp. 5ff.
118
For an overview of the development of the European venture capital industry, refer to Ooghe (1991), pp.
381ff.; Manigart (1994), pp. 525ff.
119
Gaida (2002), pp. 191ff.
120
BVK (1995-2000).
29
80
in bn €
70
60
50
40
30
20
10
Funds Raised
Investments
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Figure 6: Volume of funds raised and investments in Europe 1995–2005121
A look at the origin of the investments shows the strong dependence on institutional
investors. Their share varies over the years between 50% and 63%. The second most-
important source for venture capital is the funds-of-funds investors with a share
between 12% and 16%. The importance of corporate, private and governmental
investors differs during the years as Figure 7 shows. Generally, it can be said that the
downturn of the industry did not strongly influence the importance of the different
investor groups.
Total
38,2 26,0 25,3 23,5 67,7 funds raised
100% in bn €
75%
50% Others
Funds-of-Funds
Governmental
25% Investors
Private Individuals
Corporates
0% Institutionals
2001 2002 2003 2004 2005
Figure 7: Funds raised by type of venture capitalist in Europe 2001–2005122
In contrast to this, the downturn had an impact on the focus of the investments in
regard to the development stage of the portfolio companies. Between 2001 and 2005,
the share of late stage investments increased from 50% to 73%, which means a strong
121
EVCA (2006).
122
EVCA (2006).
30
decrease in early stage investments. In particular, investments in start-up and seed
phase companies were strongly reduced as Figure 8 shows. Venture capitalists
obviously focussed on older, more established companies after the downturn of the
new economy.
Total
24,3 27,6 29,1 36,9 47,0 investments
100% in bn €
75%
50%
Late Stage
25%
Expansion
Start-up
0% Seed
2001 2002 2003 2004 2005
Figure 8: Investments by financing phase in Europe 2001–2005123
The development shows the cycle that the European venture capital industry was
rotating through during the past ten years. In the USA, two cycles have taken place.
The cycles of fast growth and similarly fast decrease in the industry cannot be
explained by pure economic factors. It is rather the case that good expectations of
return lead to an enormous inflow of capital, which after some time leads to overin-
vestment. This decreases the generated returns, which in turn leads to a reduction of
new capital supplied.124
The development also mirrors the high investment risk caused by the characteristics of
venture capital, which are detailed in chapter 2.1.2. Good corporate governance can
reduce investment risk by effective and efficient management and control, as
explained in the next chapter.
123
EVCA (2006).
124
Gompers/Lerner (2002), pp. 4ff.; Gompers (1998), pp. 1089ff.
31
2.2 Introduction of Corporate Governance
In the following, corporate governance is defined, and then the elements of corporate
governance are explained based on several corporate governance codes. These
elements can have a bonding, monitoring or advice function. Finally, the different
influencing powers of the corporate governance of a company are described.
2.2.1 Definition
Though corporate governance has gained more public attention during the past years
because of corporate crises,125 corresponding concepts have existed for several
centuries.126 Even if today’s term was not used, Adam Smith described the concept
already in 1776:
The directors of companies, being managers of other people’s money than their own, it
cannot well be expected that they should watch over it with the same anxious vigilance
with which the partner in a private copartnery frequently watch over their own. […]
Negligence and profusion, therefore, must always prevail, more or less, in the
management of the affairs of such a company.127
Today’s definitions of corporate governance differ, particularly in regard to the scope

of the concept: Narrower and broader definitions exist, depending on the discipline in
which they are used.128 Definitions with a narrow scope focus on the relationship
between capital providers and the managers of a company such as, for example, the
definition given by SHLEIFER/VISHNY:
Corporate governance deals with the ways in which suppliers of finance to corporations
assure themselves of getting a return on their investment.129
This definition limits corporate governance to the relationship between capital

providers and management.
In contrast to this, broader definitions explicitly include other stakeholders apart from
capital providers. One corresponding definition is the one by the Organisation for
Economic Cooperation and Development (OECD):
125
Becht et al. (2002), p. 14.
126
Beiner et al. (2004), p. 2; Worldbank (1999), pp. 1ff.
127
Smith (1776) § V.1.107.
128
Huse/Landström (2002), p. 1; Kozer (2002), p. 4.
129
Shleifer/Vishny (1997), p. 737.
32
Corporate governance is only part of the larger economic context in which firms operate
that includes, for example, macroeconomic policies and the degree of competition in
product and factor markets. The corporate governance framework also depends on the
legal, regulatory, and institutional environment. In addition, factors such as business
ethics and corporate awareness of the environmental and societal interests of the
communities in which a company operates can also have an impact on its reputation and
its long-term success.130
Apart from the scope, definitions can also differ in regard to their orientation. They
can either be task oriented, i.e., focusing on the “what” of corporate governance, or
goal oriented, i.e., focusing on the “why” of corporate governance.131 A task-oriented
definition is used for example by HUSE/LANDSTRÖM: “Corporate governance deals
with how external stakeholders, internal stakeholders and the board of directors
contribute in directing an enterprise.”132 In contrast to this, MELIN/NORDQVIST give
a goal-oriented definition: “Corporate Governance can be defined as how the owners’
interest is organized and exercised in order to influence in the strategy processes.”133
This work takes a narrow scope and is task oriented as it focuses on explaining how
venture capitalists as shareholders influence corporate governance. Consequently, the
following definition is used.
Corporate governance refers to the framework of the management and control of

companies.134
2.2.2 Elements
This section describes the elements of corporate governance. This is done in relation to
corporate governance codes that present the European standards for good corporate
governance set by national or international public authorities. A huge number of
national and international corporate governance codes exist around the world; they are
adapted to different settings and partially differ in their focus.135 This work summarises
the most important corporate governance elements included in European corporate
130
OECD (2004), p. 12.
131
Neubauer/Lank (1998).
132
Huse/Landström (2002), p. 1.
133
Melin/Nordvist (2002), p. 3.
134
German Corporate Governance Code, p. 1; Bassen, (2002a), p. 20.
135
For an up-to-date overview, see ECGI (2006), for a comparison of the corporate governance codes in the
European Union, see Weil, Gotshal & Manges (2002).
33
governance codes such as the German Corporate Governance Code (GCGC) and the
Cadbury Report and the most prominent international code, the OECD Principles of
Corporate Governance. These codes include principles for good corporate governance
that should contribute to the performance of companies.136 They focus on internal
corporate governance elements that can be influenced by stakeholders of the
company.137 The elements of good corporate governance can be divided into four
groups, depending on the area of management and control to which they relate:138
Shareholder rights
Management
Board
Reporting and auditing
The elements are shown in an overview in Figure 9.
Main Corporate Governance Elements
Shareholder rights Exercise of shareholder rights
Assessment and selection of managers
Management Bonding of managers
Compensation of managers
Composition of board
Board
Work of board
Reporting and auditing Reporting discipline
Figure 9: Elements of good corporate governance
136
For more information on the development of corporate governance regulations, refer to Demirag et al.
(2000), pp. 341ff. or for the case of Germany to Peck/Ruigrok (2000), pp. 420ff. and for the case of the
United Kingdom to Short et al. (1999), pp. 337ff.
137
External corporate governance elements include, e.g., ownership structure and corporate law; for more
information refer to e.g. Joh (2003), pp. 287 ff.; Walsh/Seward (1990), pp. 421ff.
138
These catagories represent this work’s own classification in reference to the German Corporate
Governance Code, the Cadbury Report and the OECD Principles of Corporate Governance.
34
2.2.2.1 Shareholder Rights
Basically, good corporate governance should protect and facilitate the exercise of
shareholders’ rights, which include ownership, information and voting rights.139 The
ownership rights enable shareholders to own and transfer shares and to participate in
the return of the company. The information right gives shareholders the right to be
sufficiently informed on decisions concerning important corporate changes, such as
amendments to the articles of association or extraordinary transactions. Additionally,
shareholders should have the opportunity to vote in general shareholder meetings. To
effectively ensure that right, they should be provided with sufficient and timely infor-
mation on the meeting and the agenda and should have the opportunity to ask
questions of the board. Shareholders should be able to vote on important decisions
such as the compensation schemes for board members, and their voting should also be
facilitated if the shareholders are not present at the meeting.140 All shareholders of the
same series of a class should be equally treated.141
2.2.2.2 Management
Good corporate governance should ensure that the management is able and willing to
lead the company to best fulfil the goals of the shareholders and other stakeholders.142
This requires the selection of capable managers, as well as bonding these managers to
the company and the goals of the shareholders and adequate remuneration to ensure
that the managers will be willing to act in the shareholders’ interest.
The selection of new managers requires a formal and transparent process to ensure that
capable candidates are selected. The search should be done by a special committee of
the board — if the board size requires this — and should be done on the basis of a pro-
file of the required skills and experiences. The composition of management should
ensure a multiplicity of qualifications and the ability of the individual members to
work together. Apart from an effective selection of new managers, there should also be
a continuous evaluation of the managers.143 Additionally, corporate governance
should ensure that management acts in the shareholders’ interest. This can be done by
139
OECD Principles of Corporate Governance, p. 32; GCGC, pp. 3ff.; Cadbury Report, pp. 48ff.; Weil,
Gotshal & Manges (2002), pp. 33ff.; Ringleb et al. (2003), pp. 60ff.; Strieder (2004); pp. 16ff.
140
OECD Principles of Corporate Governance, pp. 32 ff; GCGC, pp. 3ff.; Weil, Gotshal & Manges (2002),
pp. 41ff.
141
OECD (2004), pp. 40ff.; GCGC, p. 3; Weil, Gotshal & Manges (2002), pp. 39ff.
142
Weil, Gotshal & Manges (2002), pp. 44ff.
35
bonding the managers to pursue the goals of the shareholders. The codes focus
particularly on providing adequate rules to prevent conflicts of interests.144 Another
element related to this is the managers’ remuneration, which should be transparent and
linked to the companies’ or the managers’ performance. Transparency serves as super-
vision of the managers. Variable compensation parts should give the managers an
incentive to realise mid- and long-term performance targets. Therefore, the compen-
sation should be related to relevant and demanding parameters.145
2.2.2.3 Board
The board composition and processes should ensure the strategic guidance of the
company, the effective monitoring of management and the board’s accountability to
the company and the shareholders. Board practices vary widely between countries, in
particular between countries with a one-tier system (one board for management and
supervision) and those with a two-tier system (two separate boards for management
and supervision). However, the principles presented are sufficiently general to apply to
both systems.
The board composition should ensure that the board is able and willing to effectively
supervise management and guide the company. This requires a sufficiently indepen-
dent and qualified board. Independence is achieved by having members on the board
that are not managers of the company and that have no relationships with them or
other stakeholders. The board is required to perform supervisory duties. Moreover, the
quality and experience of the board members affect their ability to control and guide
the company. The composition of the board with the individual members is an impor-
tant element. It should ensure that all required qualifications for an effective board are
available. Therefore, the personal characteristics of the individual members should be
assessed. Another element is the internal structure of the board, i.e., the division into
sub-committees for specific topics.146 Furthermore, the work of the board should
ensure that the duties are exercised in an effective and efficient manner. The require-
ments for its processes range from the frequency of meetings, agenda setting and
obtaining the requisite information to the determining which issues the board should
143
Weil, Gotshal & Manges (2002), pp. 51ff. and 65; GCGC, pp. 6ff.; Cadbury Report, p. 27.
144
GCGC, p. 7; Weil, Gotshal & Manges (2002), p. 49.
145
OECD Principles of Corporate Governance, p. 61; Cadbury Report, pp. 31ff.; GCGC, pp. 6ff.; Weil,
Gotshal & Manges (2002), p. 64.
146
OECD Principles of Corporate Governance, p. 58ff.; Cadbury Report, p. 25, GCGC, pp. 9ff.; Weil,
Gotshal & Manges (2002), pp. 51ff.
36
address. The main responsibilities of the board include both guiding the company on
such issues as corporate strategy and major plans of actions and supervising the
company and its management.147
2.2.2.4 Reporting and Auditing

Good corporate governance in regard to the reporting discipline should ensure that all
matters concerning the company are disclosed promptly and accurately and that the
information reported is reliable. The disclosure should include information on the
company’s financial situation, performance, ownership, risks and governance. In order
to ensure the quality of the disclosed information, the reporting should be done in
accordance with standards of accounting and financial and non-financial disclosure.
The disclosure should be done through channels that give all stakeholders equal,
timely and cost-efficient access to the information.148 An annual audit of the financial
statements should be conducted by an independent auditor to ensure that the financial
position and performance of the company is fairly represented.149
Having explained the corporate governance elements, the next step is understanding
the functions of corporate governance, i.e., what effects the elements should have.
2.2.3 Functions
Good corporate governance provides an effective and efficient framework for the
management and control of companies, which, in turn, improves company perfor-
mance.150
The elements should fulfil three functions to achieve performance improvement:

monitoring, bonding, and advice. The performance effect can be a result of cost
reduction, which is related to control by monitoring and bonding,151 or of value
147
OECD Principles of Corporate Governance p. 60ff.; Cadbury Report, pp. 20ff.; GCGC, pp. 4ff.; Weil,
148
OECD Principles of Corporate Governance, p. 49ff.; Cadbury Report, pp. 32ff.; GCGC, p. 10ff.; Weil,
149
OECD (2004), pp. 54ff.; Ringleb et al. (2003), pp. 244ff.; Strieder (2004); p. 26.
150
Jensen/Meckling (1976), pp. 305ff.; Gompers et al. (2001), p.1.
151
Becht et al. (2002), p. 22; Jensen (1993), p. 850ff.; Goergen et al. (2004), p. 2; Hillmann/Dalziel (2003),
pp. 384ff.
37
creation, which is related to advice to management152. The following explains how the
elements relate to the three functions.
Monitoring the company’s development and management’s actions can prevent

disregard for the shareholders’ interest. Several corporate governance elements
fulfil this function. The board should supervise the performance of the company
and the management and thereby prevent developments that do not contribute to
the overall goal. Reporting and the annual meeting enable shareholders and the
public to follow the course the company is taking. Accordingly, the board and the
shareholders — and also the public — should be in a position to react to a develop-
ment and change the company’s route, if required. This might lead to reduced costs
as unnecessary expenses might be prevented and thereby to reduced risk for the
company.
Bonding of the company and the managers can also lead to reduced costs by
contractual agreements or incentives. On one hand, the company can be bonded to
rules or laws that are in the interest of shareholders. Such rules often relate to the
management of a company to, i.e., limit the decision scope of the managers. On the
other hand, the remuneration of the managers can lead to a better alignment of the
shareholders’ and the managers’ goals. Bonding should prevent the company from
taking actions against the shareholders’ interest and should reduce costs and
increase performance.
Advice to the company can lead to better results and a higher achievement of the
shareholders’ objectives. In particular, the board composition can lead to a greater
knowledge, skill and experience base that should lead a company to better-
informed decision making. Thus, qualified board members can constitute
additional management capacity that might positively influence a company’s
development. Accordingly, corporate governance can lead to value creation by
better decision making.153
Figure 10 illustrates which corporate governance elements are related with which of
the three functions of corporate governance. It shows the main functions of the indi-
vidual elements.
152
Huse (2005), pp. 43 ff.; Hillmann/Dalziel (2003), pp. 385ff.; Wallman (2005), pp. 1ff.
153
Ingley/Van der Walt (2001), pp. 174ff.; Charan (1998), p 5; Hillman et al. (2000), pp. 235ff.; according to
Boeker/Wiltbank (2005), p. 124, this is particularly important in the case of growth companies.
38
Functions of corporate governance
Bonding Monitoring Advice
Exercise of
shareholder rights 9
Assessment/selection
9 9
Corporate governance elements
of managers
Bonding of
managers 9
Compensation of
managers 9
Composition of board
9 9
Work of
board 9 9
Reporting
discipline 9
9 Element tends to fulfil the function
Figure 10: Main functions of corporate governance elements
As explained, good corporate governance should ensure that the shareholders’ interest
— mainly maximisation of the company’s performance — is achieved, either by cost
reduction or value creation. There are different influencing powers that affect how the
corporate governance in a company is shaped.
2.2.4 Influencing Powers

Institutions as well as markets exert influence on the corporate governance of
companies. The different influencing powers are shown at a glance in Figure 11.
Market for corporate control

Companies with deficiencies in their corporate governance whose firm value is not
maximised run the risk of being taken over. This risk urges companies to improve
the processes and structures of corporate governance in order to increase their firm
value. Take-overs are advantageous for current shareholders, as the new owners
generally have to pay a premium for being able to buy a majority in the company.
Accordingly, take-overs might generate the firm value that the management was
not able to generate.154 As the managers risk being replaced in the case of a take-
over, the market for corporate control is an incentive for them to implement good
corporate governance.
154
Shleifer/Vishny (1997), pp. 756ff.; Gibbs (1993), p. 55; Denis (2001), pp. 206ff.; Franks/Mayer (1998),
pp. 641ff.; Franks et al. (2001), pp. 220 ff.; Renneboog (2000), pp. 1966; Gugler (2001), pp. 32ff.
39
Factor and product markets
Companies have to operate successfully in the supply and product markets to maxi-
mise firm value. Companies that fail to do so might, in extreme cases, get into
financial difficulties. Consequently, the pressure of the factor and product markets
can lead to an improvement of corporate governance.155 The markets give the man-
agers incentives to implement good corporate governance due to the default risk.
Legislators
Legislators have the authority to set the principles of management and control of
companies and thereby have a crucial influence. In particular, legislation decided
the rights of capital providers and their protection.156 The managers have to
implement the laws.
Owners
The owners of companies can exert influence on corporate governance in different
ways using both internal and external mechanisms.157 An important internal mecha-
nism is the appointment of board members, either non-executive directors in one-
tier-systems or members of supervisory boards in two-tier-systems. Board
members should control the management. Additionally, bigger shareholders can
also get in direct contact with the managers and demand improvements in the
corporate governance. External mechanisms include participation in the general
meeting, at which the managers have to render an account. Moreover, institutional
investors can increase pressure on the managers to improve corporate governance
to maximise the firm value by publishing analyses of companies.158 This shows that
the owners can exert influence both by bonding and by monitoring.
Employees
In some countries, such as Germany, employees can influence corporate gover-
nance by their representatives in co-determined supervisory boards.159 This gives
them the ability to monitor and bond managers to improve the management and
control of companies.
155
John et al. (1992), pp. 891ff.; Denis (2001), p. 207.
156
La Porta et al. (2000), pp. 4ff.; Denis (2001), pp. 198ff., Prigge (1998), pp. 953ff.; Shleifer/Vishny
(1997), pp. 750ff.; Becht (1999), pp. 1071ff.
157
Bassen (2002a), pp. 118ff.
158
Hermalin/Weisbach (2001), p. 8ff.; Becht et al. (2002), p. 78ff.
159
Gerum/Wagner (1998), p. 352; Roe (1998), p. 361ff.; Hopt (1998), p. 246ff.; Shleifer/Vishny (1986), pp.
461ff.; Holderness/Shehan (1988), pp. 317ff.; Franks et al. (2001), pp. 216ff.
40
Debt holders
Generally, debt financing can increase the incentives for managers to generate high
cashflows so the company can service borrowed capital and thereby prevent liqui-
dation.160 Furthermore, debt holders often negotiate covenants that bond the
company to observe certain rules.161 Finally, in some countries it is common for
banks to send representatives to supervisory boards.162 Accordingly, debt holders
bond and monitor managers to improve corporate management and control.
Market for corporate Corporate governance

control
Shareholder rights
Factor and product
markets
Legislators Management
Owners
Board
Employees
Debt holders
Reporting and auditing
Figure 11: Influencing powers of corporate governance
The explanation of why and how these powers influence corporate governance might
differ for different theories.163 However, the influence of the different powers should
lead to an improvement of the management and control of a company. In growth com-
panies, venture capitalists, as the first significant external owners, are expected to be
the main influencing powers apart from the factor and product markets. This is
because the significance of the other four powers is limited. The markets for corporate
control are relatively weak due to the managerial ownership and the fact that the
companies are privately held. The corporate governance codes that legislators intro-
duced generally do not apply to private companies. Most growth companies do not
have a formal co-determination by employees due to their size. Finally, debt plays a
160
Jensen (1986), p. 324; Denis (2003), p. 205; Shleifer/Vishny (1997), p. 757ff.;
161
Drukarczyk/Schmidt (1998), p. 761 ff; Hertig (1998), p. 809ff.; Renneboog (2000), p. 1967.
162
Kroszner/Strahan (2001), p. 416ff.; Prigge (1998), p. 957.
163
Refer to 3 for explanations of agency theory and the dynamic resource-based view.
41
small role because growth companies are mainly equity financed.164 Hence, the
influence of venture capitalists is expected to be of great importance for the develop-
ment of corporate governance and is accordingly analysed in this thesis.
164
Refer to 2.1.2 for characteristics of venture capital-financed growth companies.
42
3 Theoretical Foundations
Different theories explain the relation between venture capital and corporate
governance from different perspectives. In order to ensure a comprehensive
understanding of the relationship, this work combines two disciplines related to the
different functions of corporate governance: agency theory as an economic perspective
and the dynamic resource-based view as a managerial theory. Whereas agency theory
focuses on the control functions of monitoring and bonding, which restrain the
managers, the dynamic resource-based view165 centres on the advice function of corpo-
rate governance.166 Consequently, the importance of corporate governance for the
success of venture capitalists is judged differently by the two theories. Nonetheless, as
the following introduction of the theoretical foundations shows, both theories consider
corporate governance as a key factor for the success of growth companies and thereby
for venture capitalists.
3.1 Agency Theory

3.1.1 Introduction
3.1.1.1 Origination
Agency theory is one of the streams of the new institutional economics developed
from the 1950s to compensate for the deficits of neoclassic economic theory, which
was built on the assumption of perfect markets with perfect information and foresight.
The new theories take institutional arrangements into account, try to explain them and
try to derive recommendations for an optimal arrangement of institutions. Their key
message is that institutions matter for economic performance.167 Institutions are
systems of norms and their guarantees that are targeted at specific utilities and that
steer individual behaviour in a specific direction.168 Apart from agency theory, property
165
For more information on the suitability of the dynamic resource-based view to analyse growth companies,
refer to Alvarez/Busenitz (2001), pp. 755ff.
166
Lynall et al. (2003), pp. 417ff.; Hung (1998), pp. 104ff.; Daily et al. (2003), pp. 371ff.; for more
information on the value of combining the dynamic resource-based view with organizational economics.
refer to Combs/Kechen (1999), pp. 867ff. or Conner (1991), pp. 121ff.
167
Feldman (1995), pp. 1693ff.; Bradley et al. (1984), pp. 857 ff; Furubotn/Richter (2000), pp. 1ff.
168
Richter/Furubotn (2003), p. 513.
43
rights theory and the transaction cost approach are the most important approaches of
the new institutional economics.169
Agency theory in particular was developed on the basis of economic literature

describing risk sharing among individuals and groups in the 1960s and early 1970s. It
broadened this view by including the case that cooperating parties with separate tasks
have different goals.170 Agency theory has developed two streams — positivist agency
theory and principal-agent theory — which share assumptions but differ in their
mathematical rigor and style. Whereas the positivist agency theory focuses mainly on
the relationship between owners and managers of companies, the principal-agent
theory is applied also to other relationships such as the employer–employee or buyer–
supplier relationships. The positivist stream identifies the governance mechanisms that
limit an agent’s self-serving behaviour and the latter stream indicates which contract is
the most efficient under varying conditions. The principal-agent theory involves
careful specification of assumptions that are followed by logical deduction and mathe-
matical proof. In contrast to this, the positivist stream is less mathematical.171 This
work is mainly based on the positivist stream of agency theory.
3.1.1.2 Assumptions
Agency theory deals with incentive and control problems in the event of asymmetrical
allocation of information between two parties, the principal and the agent. According
to the theory, the two parties have different utilities that they both try to maximise. The
aim of the theory is to find an optimal organisation of a principal–agent relationship.172
It explains performance differences as a result of agency costs that occur because of
the separation of ownership and control.
The agent is better informed than the principal and tries to benefit from this informa-
tion advantage by maximising his own utility, which can have negative effects on the
utility of the principal. Three types of possible agency problems must be
differentiated:173
169
Rau-Bredow (1992), p. 1.
170
Eisenhardt (1989a), p. 58.
171
Eisenhardt (1989a), pp. 59ff.
172
Jensen/Meckling (1976), pp. 309ff.; Ross (1973), p. 134, Grossman/Hart (1983), p. 7.
173
Jensen/Meckling (1976), pp. 305 ff; Amit et al. (1998), pp. 442ff.; Spreemann (1990), pp. 562ff.;
Holström (1979), pp. 74ff.; Alchian/Woodward (1988), pp. 67ff.; for an analysis of the venture capitalist–
manager of the portfolio company relationship, refer to Amit et al. (1990), pp. 1232ff.
44
Adverse Selection
The principal cannot differentiate between good and bad agents before the closing
of a contract because he does not know about certain characteristics of the agents
(hidden characteristics).
Hold-up
After the closing of a contract, the agent uses gaps in incomplete contracts for his
own benefit.174 Intentions that were not displayed before (hidden intentions) are
now revealed and force the principal to renegotiate with the agent.
Moral Hazard
The agent benefits from information that the principal does not have (hidden
information) or from actions that the principal cannot see (hidden action), which
decreases the utility of the principal without his knowledge.175
According to agency theory, measures have to be taken to align the interests of the
agent and the principal. These measures are costly. Generally, there are two different
measures.176
Bonding
Agency problems can be reduced by binding the interests of the agent to those of
the principal. This can be done either by contracts or by incentives. Contracts limit
the scope of the agents and should thereby prevent actions that do not maximise the
utility of the agent. Incentives should lead to an alignment of the interests of the
two parties so that the agent maximises the utility of the principal in his own
interest.
Monitoring
The monitoring of the agent can also reduce agency problems by reducing the
information asymmetries between the two parties. Problems can arise if the
principal lacks the ability to monitor the agent.
Agency costs are the difference between the resulting utility of the principal and the
utility in the optimal case without agency problems. They consist of two components.
174
For a theoretical analysis of incomplete contracts in the venture capitalists–manager of portfolio company
relationship, refer to Aghion/Bolton (1992), pp. 473ff.
175
For a theoretical analysis of moral hazard and observability, refer to Holmström (1979), pp. 74ff.
176
Denis (2001), pp. 195ff.; Schoppe et al. (1995), pp. 218ff.
45
The principal has expenses for the measures to reduce agency problems, namely
bonding and monitoring of the agent.
There are residual losses that cannot be reduced by these measures due to reasons
of efficiency.177
In the case of a principal–agent relationship between shareholders and managers of a

company, five types of residual losses can be distinguished.178
Shirking: Managers use their work time to follow their private interests instead of
pursuing the goals of the shareholders.
Consumption on the job: High expenses for perquisites such as plush offices and
corporate jets reduce a company’s financial resources.
Managers’ desire to remain in power: When current managers cannot fully realise
firm value, they should be replaced. As managers generally do not like to lose their
positions, this might lead to a conflict of interest with the shareholders that can be
long lasting and associated with high costs for the company and its owners.
Managerial risk aversion: Managers and shareholders of a company might bear

different levels of risk. Shareholders normally own a well-diversified portfolio so
that the holdings in one company represent only a small share of their wealth.
Therefore, they might be interested in cashflow-positive investments, even if they
are risky. In contrast to this, managers have the majority of their human capital tied
to one firm only, which makes them generally more risk averse.179 Therefore,
managers could be unwilling to pursue cashflow-positive but rather risky projects
that are worthwhile from the shareholders’ perspective. Such a foregone invest-
ment is a cost for the owners of the company.
Free cashflow: Managers might prefer to keep the capital invested in the company
within the firm if possible. Whereas it would be in the interest of shareholders to
have any capital that cannot be invested in profitable projects in the firm paid out,
the managers might invest free cashflows in unprofitable projects or hold onto
177
Jensen/Mecklin (1976), pp. 5ff.; Schoppe et al. (1995), pp. 218ff.
178
Denis (2001), pp. 193ff.; Tirole (2001), pp. 1ff.; for an analysis of agency problems in the venture
capitalists–managers of portfolio companies relationship, refer to Duffner (2003), pp. 38ff.
46
them. This corresponds to costs for the shareholders as they might possibly invest
their money more profitably elsewhere.
An optimal organisation of the relationship between principal and agent is reached if

the occurring agency costs are minimal.180 This leads to differences in performance
and, in turn, in the valuation of companies.
3.1.2 Venture Capital and Corporate Governance

3.1.2.1 Understanding of Corporate Governance
Agency theory considers corporate governance a way to reduce agency problems.
Corporate governance is seen as the framework for the relation between the owners
and the managers of a company. It includes the contracts between them, the bonding
measures designed to motivate managers to act in the interest of the owners, and the
monitoring of the company and the managers. These processes and structures should
restrain potentially opportunistic managers and thereby reduce the associated risk.
Agency theory focuses on the bonding and monitoring function of corporate gover-
nance as explained in the last section. Corporate governance that effectively bonds and
monitors managers should minimise agency costs and thereby lead to increased
value.181
3.1.2.2 Importance of Corporate Governance for Growth Companies

At the time venture capitalists enter a relationship with a portfolio company, the
information asymmetries and the level of uncertainty are typically great, and tangible
assets that could serve as collateral are scarce.182
Generally, venture capitalists face four agency problems when investing in growth
companies. First, the managers of the portfolio company might know more about their
quality and abilities than the venture capitalists (adverse selection). Second, the
investor is concerned that after an investment, circumstances will arise in which the
venture capitalist disagrees with the management (moral hazard). Third, the investor is
179
For a theoretical analysis of managerial risk taking, refer to Wiseman/Gomez-Mejia (1998), pp. 133ff.;
this conflict of interest is particularly severe in research intensive industries where shareholders prefer
innovation strategies whereas managers prefer diversification strategies; for more information refer to
Hill/Snell (1988), pp. 577ff.
180
Schoppe et al. (1995), p. 214.
181
Huse (2005), p. 43; Jensen/Meckling (1976), pp. 305 ff.
182
Arthurs/Busenutz (2003), pp. 145ff.
47
concerned that the entrepreneur will not work hard to maximise the company’s value
after the investment decision (moral hazard). Finally, the entrepreneur can hold up the
venture capitalist by threatening to leave the portfolio company, in particular when his
or her human capital is very valuable for the company’s development (hold-up).183
These agency problems occur in portfolio companies that are additionally affected by a
high degree of inherent uncertainty.184 This further strengthens the investment risk and
thereby the need for managers to be effectively bonded and monitored.
Moreover, venture capitalists are confronted not only with a high degree of risk but
also with a weak market for external control and limited oversight by the public, which
increases the importance of strong influence by the owners. 185 That is why investors
need to implement adequate corporate governance structures to handle the risks
associated with investments in young innovative companies.186
The importance of good corporate governance depends, according to agency theory,

on the level of agency and business risk.187 The following details why these forms of
risk are particularly great in growth companies.
High agency risk: Agency risk concerns the probability that managers will make
decisions that do not maximise the wealth of the investors.188 Growth companies are
built on special opportunities. The entrepreneurs or the managers of growth companies
must recognise and capitalise on opportunities that others cannot yet see in order to
gain high growth.189 Thus, managers in growth companies have a role of unique
importance: being the centre of control and decision making.190 The very
characteristics of growth companies cause their relatively high level of agency risk.
More specifically, the following four characteristics of growth companies make it
difficult for venture capitalists to effectively bond and monitor portfolio companies.191
The business of growth companies stands out because of its high specificity. As
innovation increases, complexity also increases. This demands higher information
183
Kaplan/Strömberg (2004), pp. 2177ff.
184
Sapienza/Gupta (1994), p. 1618ff.
185
Sapienza/Gupta (1994), p 1618.
186
Hoffmann (2003), p. 130.
187
188
Jensen/Meckling, 1976, pp. 308ff.
189
Shane (2000), p. 448.
190
Begley/Boyd (1987), pp. 79ff.
191
Bassen et al. (2006b), pp. 128ff.
48
processing capabilities, which increases the agency problems.192 Owners who lack
such high information processing capabilities might not be able to fully understand
the business, its associated risks and the information on its development. Additio-
nally, the managers are reluctant to fully disclose specific information in order to
prevent others from pursuing opportunities the company is building on.193 This
makes it even more difficult to closely follow and control the development of a
growth company, which thereby facilitates opportunistic behaviour by the
managers who possess the specific knowledge.
A comparatively great part of the companies’ assets is intangible or difficult to

quantify such as patents, rights and specific know-how.194 A high proportion of
immaterial assets makes control of the managers even more difficult because the
value and development of such assets are difficult to judge. Additionally, tradi-
tional accounting measures of firm performance and development may be of
limited usefulness in monitoring growth companies because they do not reflect
important factors such as the value of intangible assets.195 This increases the possi-
bility of intentional misinformation of the owners by the managers.196
Due to their short history, growth companies lack a track record and a high
profile.197 That means little information is available about the previous development
of a business, making it hard for outside owners to evaluate it. Moreover, without
historic information, managers can more easily present a false picture of the
business.198
The characteristic of managerial ownership of growth companies can strengthen

or weaken the associated agency risk. There are two different hypotheses — both
empirically supported — that predict either positive or negative consequences of a
partial ownership of the management.
According to the convergence of interest hypothesis, managerial ownership should

increase a company’s value by aligning the interests of owners and managers.199
192
Markman 2001, p. 289.
193
Shane/Cable (2002), p. 365.
194
Küting (2000b), p. 674; Blair/Wallman (2003), pp. 451ff.
195
Engel et al. (2002), p. 488.
196
Gompers/Lerner (2001), p. 155.
197
Hayn (1998), p. 15.
198
Smith/Smith (2000), p. 399; Achleitner/Bassen (2002), p. 1194.
199
Morck et al. (1988), p. 294.
49
Because the managers are also owners of the company, they should target value
maximisation of the company just as the other owners do. Supporting this hypo-
thesis, the likelihood of opportunistic behaviour, especially consumption on the
job, increases with the amount of outside equity.200 This shows that the managers
have incentives to maximise firm value when they own part of the company.
In contrast to this, the entrenchment hypothesis predicts that managers with a sub-
stantial share in the company can have negative effects on the value of the firm for
the owners. By means of influence and voting rights, they can guarantee their
employment at attractive conditions rather than increase the value of the
company.201 According to this hypothesis, managers prefer to increase their living
standards by taking advantage of their employment rather than by increasing the
value of their shares of the company. BAKER AND GOMPERS (1999) present an
overview of different consequences of managerial ownership of the company: The
managers might be immune to career concerns,202 the discipline of the product
market,203 monitoring by large shareholders204 and value enhancing take-overs205.
This hypothesis is corroborated by analysing the relationship between firm value
and managerial voting power related to their ownership. It can be shown that firm
value is positively related to voting power if this is small, but negatively related to
voting power if it becomes large.206 Empirically, it is shown for large firms that
management ownership has a positive effect on the firm value if the stake is
smaller than 5%; it has a negative effect if the stake is between 5% and 25%, and
the effect becomes positive again for stakes over 25%. This supports the entrench-
ment hypothesis for stakes between 5% and 25% as such an ownership level is
associated with, among other things, increased voting power and dominance of in-
side directors.207 Such a curve-linear relationship between shareholdings of officers
and directors and firm value is also shown empirically by MCCONELL/
SERVAES208 and, for Switzerland, by BEINER ET AL209.210
200
Jensen/Meckling (1976), p. 346.
201
Morck et al. 1988), p. 294; Jensen/Warner (1988), pp. 6 ff.
202
Fama (1980), pp. 288ff.; Holström (1999), pp. 169ff..
203
Hart (1983), pp. 366ff.
204
Shleifer/Vishny (1986), pp. 461ff.
205
Jensen/Ruback (1983), pp. 5ff.; Franks/Mayer (1990), pp. 189ff.
206
Stulz (1987), p. 32ff.
207
Morck et al. (1988), pp. 300ff.
208
McConell/Servates (1990), pp. 601ff.
209
Beiner et al. (2004), p. 29.
50
High business risk: Business risk is determined by the probability of survival of a
business, which is predominantly dependent on its profitability. Therefore, the level of
business risk is a function of the uncertainty of profitability.211 In particular, the
following three characteristics of growth companies imply a comparatively high level
of business risk.
Growth companies normally operate in highly dynamic environments. To

succeed in these industries and to realise high growth, constant change is required,
which leads to a high degree of internal dynamic. They are often exploring markets
where competitive equilibriums among buyers, suppliers, potential entrants, current
competitors, and product or service substitutes have not been established.212 Growth
companies normally cannot take advantage of a high profile in the market, which
makes them more vulnerable. Additionally, they typically are built on the
challenging assessment and government of innovation, which has become even
more difficult during the most recent decades as information technologies and the
globalization of industries have blurred industry confines and fragmented
competition.213
Because the environment of growth companies is so dynamic and their markets are
highly competitive, they are required to respond quickly to changing conditions in
order to succeed. This requires great flexibility, which leads to a high degree of
internal dynamic.214 The internal processes undergo constant change rather than
being firmly established, which increases the risk.215 As the internal and external
dynamism increase, so does the risk that a company is unprofitable.
Growth companies are highly dependent on their managers. Their managers are in
many cases the founders who still own parts of the company.216 They have specific and
unique knowledge about the companies’ opportunities and assets as well as the capa-
bilities to exploit them.217 Moreover, they possess information about the day-to-day
210
It should be noted that the analysis by Himmelberg et al. (1999) did not find an effect of managerial
ownership on firm performance.
211
Barney et al. (1989), p. 64; Porter (2004), pp. 5ff.
212
Porter (2004), pp. 215ff.; Fiet (1995), p. 555; Küting (2000a), p. 597.
213
Prahalad/Hamel (1994), pp. 5ff.
214
McGuire (2000), p. 33.
215
Auge-Dickhut et al. (2000), 4.3.2.1.
216
Bessler et al. (2001), p. 254; He/Conyon (2004), pp. 53ff.
217
Kirzner (1997), pp. 67ff.
51
business and its future prospects.218 That means that the success of the business is
highly dependent on the entrepreneurs or managers and their personal knowledge and
experience, which can have four negative consequences: First, managing growth
companies makes great demands on the capabilities of the managers. The team is often
small, and its experiences are limited, and there are always more problems than the
managers can handle at any given time.219 Thus, the quality of the managers constitutes
an important risk factor for the success of the company. Second, there might be
negative consequences if the managers leave the company because they would take
key knowledge and experiences with them and leave the company without leadership
— the organisation is in many cases centred on them. Third, the possibility of
opportunistic behaviour is very high because the managers possess information that
the owners lack.220 They can make use of this information and act against the interest
of the outside owners. Finally, the likelihood of opportunism is increased because the
managers mainly make the decisions and might be more risk averse than the owners of
a company.221 This is because managers invest most of their non-diversifiable and non-
tradable capital in the growth firms, whereas the owners can more easily diversify risk
by investing parts of their wealth in different companies.222 Thus, managers might be
reluctant to invest in risky but cashflow-positive projects. Such risk-averse decision
making might lead to lower returns for the owners. This is reflected by the findings of
RUHNKA/YOUNG that managerial competence is among the greatest concerns of
venture capitalists223 as well as by those of GORMAN/SAHLMAN that investors
explain the reason for venture failure to be managerial incompetence.224 Additionally,
KAPLAN/STRÖMBERG found that the managers were the primary internal risk of an
investment in the opinion of venture capitalists.225
In companies with great growth prospects, managers’ efforts can have a relatively
large impact on firm performance. This is why risk is comparatively higher in these
companies than in more traditional ones.226
218
Markman et al. (2001), p.275.
219
Fredriksen/Klofsten (2001), p. 203.
220
221
Coffee (1987), p. 18; Jensen/Meckling (1976), p. 349.
222
Markman et al. (2001), p. 280.
223
Ruhnka/Young (1987), pp. 167ff.; Sapienza et al. (1996), p. 445.
224
Gorman/Sahlman (1989), pp. 231ff.; Sapienza et al. (1996), p. 445.
225
Kaplan/Strömerb (2004), p. 2190.
226
Smith/Watts (1992), pp. 263ff.
52
Growth companies generally have a low level of diversification as they operate only
in a small number of business areas, producing and offering few product lines.227 In
high technology firms, new products, for example, count for more than 50% of their
annual sales.228 This increases the business risk of a company because its survival is
dependent on only a few products.229
A highly dynamic environment, dependence on the managers, and little diversification

are three important factors that cause a high level of business risk. And this business
risk reinforces the importance of corporate governance in two ways. First, the conse-
quences of opportunistic behaviour by the managers are more severe in the case of
high business risk. Second, such opportunistic behaviour is more likely if the business
risk is high because of the different risk structures of owners and managers.
Combining the high level of agency and business risk associated with growth
companies, agency theory ascribes high attention to corporate governance for the
success of those companies and their investors.
3.2 Dynamic Resource-based View

3.2.1 Introduction
3.2.1.1 Origination
The dynamic resource-based view is a recent adaptation of the resource-based view.230
The resource-based view has been developed as a counterpart to the market-based
view, which was the dominant paradigm to explain competitive advantages in the
1980s.231 Whereas the latter focuses on the attributes of attractive industries that offer
opportunities for companies to succeed, the resource-based view centres on analysing
the resource endowment of firms.232
The market-based view makes the assumption that firms in one industry possess
identical resources and that potential resource heterogeneity in industries lasts only for
a short time. Thus, it analyses the impact of a firm’s environment on its
227
Küting (2000a), pp. 600ff.
228
Schilling/Hill (1998), pp. 67ff.
229
Küting (2000a), pp. 600ff.
230
Helfat/Peteraf (2002), p. 1.
231
Barney (1990), p. 100; Teece et al. (1997), p. 510; for an analysis of the usefulness of firm analysis from
the resource rather than from the product side, refer to Wernerfelt (1984), pp. 171 ff.
232
Barney (1990), p. 100.
53
performance.233 In contrast to this, the resource-based view analyses the impact of a
firm’s internal characteristics on its performance.234
The aim of the approach is to explain the relationship between a firm’s resources and
its performance.235 Competitive heterogeneity is explained on the premise that compe-
titors differ in their important resources and capabilities in a durable way, which
should result in competitive advantages and disadvantages. However, the relationship
between resources and performance does not necessarily have to be static.236 Compe-
titive advantage arises in time and might also shift over time. Therefore, given the
external dynamics, the dynamic resource-based view incorporates the evolution of
resources that form the basis for competitive advantage.237 An important contribution
to this theory is the recently developed dynamic capabilities approach, which focuses
on the importance of capabilities in reconfiguring other resources.238
3.2.1.2 Assumptions
The following introduces the well-established assumptions of the resource-based view
and then explains the adaptation of the dynamic resource-based view. The resource-
based view is built on two assumptions: Firms possess strategic resources that are
valuable and rare, and to sustain competitive advantages over time, strategic resources
must be imperfectly imitable and substitutable. These assumptions enable a firm to
achieve a sustainable competitive advantage “when it is implementing a value creating
strategy that is not simultaneously being implemented by any current or potential
competitors […] and these other firms are unable to duplicate the benefits of this
strategy.”239
Firms possess strategic resources that are valuable and rare. Firm resources are
assets, capabilities, organizational processes, firm attributes, information and know-
ledge that are controlled by a firm and enable it to implement strategies to improve
efficiency and effectiveness.240 They could be classified into three categories:241
233
Barney (1990), p. 101.
234
Barney (1990), pp. 101ff.; Teece et al. (1997), pp. 513ff.
235
Barney (1990), pp. 100ff.
236
Helfat/Peteraf (2002), p. 1; it should be noted that competitive advantage might not lead to performance
because of stakeholder power, for more information refer to Coff (1999), pp. 119ff.
237
238
Teece et al. (1997); Eisenhardt/Martin (2000).
239
Barney (1991), p. 102.
240
Barney (1991), p. 101; Daft 1983, pp. 539 ff.
241
Barney (1991), p. 101.
54
Physical capital resources include assets such as plants, equipment and physical
technology but also geographic location and access to raw materials.242 Human capital
resources include experience, talent, judgement, insight, training, and relationships of
a firm’s employees.243 Organisational capital resources include a firm’s formal and
informal planning, coordination systems, and informal relations among groups within
a firm or between a firm and its environment.244 Physical capital resources are also
categorised as tangible resources; human and organisational capital resources are
intangible.245
Strategic resources can be sources of sustained competitive advantage. They must be

valuable. That means that the resources enable a firm to implement strategies that
improve its effectiveness and efficiency and thereby are the source of a competitive
advantage. Furthermore, they must be rare because a firm can gain a competitive
advantage only by implementing a strategy that is not simultaneously implemented by
many of its competitors.246 The rareness often comes from the path dependency of
strategic resources, which means that strategic resources are not freely acquirable.
Thus the potential of a firm is dependent on its current position, which is often shaped
by its previous path.247 Because strategic resources cannot be imitated or substituted
they are not tradable. Hence, firms build and accumulate strategic resources over time
by choosing appropriate paths over time. For example, a reputation for quality can be
achieved by following consistent production and quality control policies for a long
time. Consequently, strategic resources cannot be achieved instantaneously but only
over time.248
Thus, endowment with strategic resources requires the assumption of heterogeneous

firms’ resources.
To sustain competitive advantages over time, strategic resources must be

imperfectly imitable and substitutable. There are three reasons why strategic resour-
ces can be difficult to imitate. First, strategic resources could be imperfectly imitable
242
Williamson (1975); Barney (1991), p. 101
243
Becker (1964); Barney (1991), p. 101.
244
Tomer (1987); BARNEY (1991), p. 101.
245
Hall (1992), pp. 136ff.; Hall (1993), pp. 607ff.; Michalisin et al. (1997), pp. 361ff.
246
Barney (1991), p. 106; for a theoretical analysis refer to Peteraf (1993), pp. 179ff.
247
Teece et al. (1997), p. 522, this is a major difference from microeconomic theory, which does not
recognise the limitedness of resources; for more information on the path dependency of management in
growth companies, refer to Beckman/Burton (2004), pp. 1ff.
248
Dierickx/Cool (1989), p. 1506.
55
because of the unique history of firms. The resource-based view assumes that a firm’s
abilities to acquire and exploit resources depend on time and space, namely the unique
historical position of that firm. Hence, after a particular time period has passed, firms
that did not acquire particular space- and time-dependent resources cannot obtain them
anymore. Consequently, these resources are imperfectly imitable.249 Second, a strategic
resource could be difficult to imitate because of causal ambiguity.250 Causal ambiguity
means that the link between a firm’s resources and its sustained competitive advantage
is not understood at all or only very badly. In that case, success cannot be traced back
to specific resources. This makes it difficult for competitors to imitate strategic resour-
ces and thereby gain a competitive advantage. This ambiguity must hold for the firm
and its competitors in order to prevent the competitors from engaging in activities to
reduce the information differences.251 The incomplete understanding of a source of
competitive advantage might be due to the complexity and interdependency of a firm’s
resources.252 Third, strategic resources could be difficult to imitate because of social
complexity. In this context, a strategic resource could be or could be based on a firm’s
culture, reputation or customer base or the interpersonal relations between managers in
the firm.253 Here, the relation between a firm’s resources and its performance is well
understood, but nevertheless competitors fail to imitate the resources. This is because
these resources are connected to social activities or attributes of a firm and its
employees that might be beyond most firms’ abilities to duplicate.254
The imperfect substitutability of a strategic resource means that there must be no

strategically equivalent valuable resources with which the same strategies could be
implemented. If a particular strategy to improve effectiveness and efficiency can be
implemented only with the strategic resources of a firm, then those resources can be
the source for sustained competitive advantage.255 The imitability is in large part a
function of observability, and the imitability of competitive advantage depends on the
imitability of its underlying resources. The more unobservable a competitive advan-
tage is, the more sustaining is it. Intangible resources are more unobservable than
249
Barney (1991), pp. 107ff.; examples for firms that obtained strategic resources because of their historical
position can be found e.g. Leaned et al. (1969), Miles/Cameron (1982).
250
Barney 1986b, Lippman/Rumelt (1982), pp. 421ff., Mancke (1974), Rumelt (1984).
251
Lippman/Rumelt (1982), pp. 418ff.; Barney (1991), p. 109.
252
Nelson/Winter (1982); Polanyi (1962); Barney (1991), p. 110.
253
Hambrick (1987); Barney (1986b); Porter (1980); Klein et al. (1978); Klein/Leffler (1981).
254
Barney (1991), p. 110.
255
56
tangible resources and are therefore difficult to imitate. That is why strategic resources
are often intangible.256
Physical, tangible resources are generally not rare because they can be purchased in
the open market and are susceptible to imitation.257 A supplier might provide a
particular buyer with exclusive rights to some physical technology by a contract or
license. But it is not the technology that is rare in this case but the intangible contract
or license. It contains the potentially valuable, nonsubstitutable resource-based
advantage that is imperfectly imitable.258
Recently, scholars have argued that the assumptions of the traditional resource-based
view neglect two aspects. First, the sustainability of a competitive advantage is
questionable. This is because changes in the environment may change the value of
resources and thereby competitive advantages.259 A competitive advantage in one time
period can lose its value in another period. Apart from this, the resource-based view
considers only internally developed resources, but it ignores exchanges, acquisitions or
leveraging of resources.260 This relates in particular to the abilities of firms to also use
external resources for building a competitive advantage.261 To compensate for this, the
dynamic resource-based view incorporates the dynamics involved in the environment
and focuses on dynamic capabilities as strategic resources that reconfigure other
resources.
Dynamic capabilities “are the organizational and strategic routines by which firms
achieve new resource configurations as markets emerge, collide, split, evolve and
die.”262 These routines have three roles: coordinating and integrating the assets and
activities in the firm, learning to improve the resource-base and the activities, and
reconfiguring and transforming the resources and activities to reflect changes in the
environment. Thus, it is argued that a firm’s competitive advantage lies with its man-
agerial and organizational processes.263 They govern the change of the capabilities of a
256
Godfrey/Hill (1995), p. 523; Michalisin et al. (1997), pp. 364ff.
257
Michalisin et al. (1997), p. 364; Galbreath/Galvin (2004), p. L1.
258
Hall (1992), p. 138; Michalisin (1997), p. 364.
259
Helfat/Peteraf (2002), p. 2; Hillman et al. (2000), p. 242; Peteraf/Bergen (2003), pp. 1038ff.
260
Mathews (2002), p. 31.
261
Knott et al. (2003), pp. 192ff.
262
Eisenhardt/Martin (2000), p. 1107.
263
Teece et al. (1997), pp. 515 ff; according to these authors it was revealed that successful companies
demonstrate timely responsiveness and rapid and flexible product innovation, which is coupled with
management capability to effectively coordinate and redeploy internal and external competences.
57
company.264 Dynamic capabilities consist of identifiable and specific routines. For
example, in strategic decision making, managers pool their expertise and knowledge to
make choices that shape the strategic moves of their company. Other examples include
the research and development process or the processes of transferring and distributing
resources.265
Even though the dynamic resource-based view is still developing, it seems to ease
some of the restrictive assumptions of the traditional resource-based view. In parti-
cular, not all four conditions of strategic resources are required for dynamic capa-
bilities. Competitive advantages arise from valuable, somewhat rare, equifinal
dynamic capabilities that might be substitutable and fungible. But these competitive
advantages are not sustainable. The heterogeneity is not firm specific but rather based
on best practice that might incorporate some idiosyncratic details. Apart from that, the
path dependency of the evolution of resources is determined by learning mechanisms
such as practice or codification, which stress the dynamics of the evolution.266
The dynamic resource-based view explains performance differences between firms

using differing endowments of strategic resources,267 in particular dynamic capabilities.
Dynamic capabilities reconfigure the resources of a company to match the environ-
ment in the best way, which should lead to competitive advantages. They can be
developed and managed by a company268 so that they reflect its competitive environ-
ment.269 The competitive advantage can either be a lower cost base or product differen-
tiation. This, in turn, should result in better company performance.
This shows that the dynamic resource-based view is not a new approach but an adap-
tation of the resource-based view.
264
Winter (2003), p. 992; according to Winter, there are different levels of organisational capabilities;
dynamic capabilities govern the change of ordinary — or lower level — capabilities.
265
266
267
For an analysis of the performance effects of resource endowments of entrepreneurial companies, refer to
Lee et al. (2001), pp. 615ff.
268
Resource management includes the evaluation and expansion of the resource endowment (“resource
inventory”), the bundling of the resources and the leveraging of resources. And the effectiveness and
efficiency of this coordination might be or might at least lead to a competitive advantage. For further
explanations see Sirmon/Hitt (2003), pp. 339ff.; Powell (1992), pp. 120ff.
269
Helfat/Peteraf (2002), pp. 8ff.; Sirmon/Hitt (2003), pp. 344ff.
58
3.2.2 Venture Capital and Corporate Governance
3.2.2.1 Understanding of Corporate Governance
The dynamic resource-based view considers corporate governance to be either a
potential source of competitive advantage270 or at least a resource that enables a firm to
gain a competitive advantage from other strategic resources.271
Corporate governance is the framework for management and control of a company;272

it determines how decisions are made. Decision making is a dynamic capability that
coordinates and configures a company’s internal and external resources.273 Good
corporate governance means that companies have a good decision making process.
This requires that decisions be made based on the best information available, taking
into account several alternatives274 and the company’s goals, which are generally
related to value creation. Good corporate governance leads to informed decision
making. Well-informed decisions might be good decisions and could therefore lead to
a competitive advantage.275 Corporate governance determines a company’s ability to
make informed decisions. In a nutshell, corporate governance determines the pro-
pensity of a company to create competitive advantage.276
According to the dynamic resource-based view, good corporate governance enables a

firm to effectively and efficiently configure its resources to gain competitive advan-
tage. This is reached by using the best basis for decision making, which is largely
determined by the experiences and skills of the people involved. The improvement of
corporate governance is focussed on the structures and processes that facilitate making
270
This is a perspective often found in research on the corporate governance of family firms, e.g., Carney
(2005), pp. 249 ff; indirectly Barney/Hansen (1994), p. 188 also consider corporate governance as a
source of competitive advantage.
271
Barney et al. (2001), p. 632; Collis (1994), p. 143 states that organisational capabilities — which are
partly determined by corporate governance — are a valuable resource of competitive advantage.
272
German Corporate Governance Code, p. 1; Bassen, (2002a), p. 20.
273
Eisenhardt/Martin (2000), p. 1107; c.f. McGee (1995), pp. 577ff.
274
For more information on the rationalism of comprehensive strategic decision processes, refer to
Fredrickson (1984), pp. 445ff.
275
Eisenhardt (1989b), pp. 549ff.; Eisenhardt/Martin (2000), p. 1106; Adner/Helfat (2003), p. 1020; Winter
(2003), pp. 993ff. explains why the advantages of dynamic capabilities can be compensated by costs or
competition.
276
Carney (2005), p. 249; Castanias/Helfat (1991), pp. 161ff.; Acquaah (2003), p. 64; Lynall et al. (2003),
pp. 418.
59
decisions on the best possible basis. Accordingly, the dynamic resource-based view
considers the advice function of corporate governance as particularly important.277
Good corporate governance can lead to a company’s competitive advantage and is

therefore either seen as a strategic resource itself or as a condition for other strategic
resource decision making.278
The empirical analysis by ACQUAAH provides evidence that the effectiveness of

management leads to a sustainable competitive advantage, which shows in sustainable
abnormal profitability. Additionally, it was found that managerial capabilities are a
particularly strong predictor of sustained over-performance, which reinforces that the
effectiveness of management is a valuable, unique and difficult-to-imitate resource.279
3.2.2.2 Importance of Corporate Governance in Growth Companies

As introduced before, competitive advantages arise from valuable and somewhat
dynamic capabilities.280 Good corporate governance as the framework for decision
making is particularly valuable and rare in growth companies, as the following shows.
Besides this, corporate governance has additional characteristics that make it difficult
to imitate. Though, due to the equifinality of decision making and changing require-
ments, the sustainability of competitive advantage resulting from good corporate
governance is questionable.
Valuable: Growth companies often operate in highly dynamic markets.281 In such

markets — also described as ‘high-velocity markets’ — change is hardly
predictable, and successful business models are unclear.282 Here, dynamic capa-
bilities are particularly valuable as it is constantly necessary to learn how to adapt
to the changing market and to quickly build and reconfigure firms’ resources and
277
Adner/Helfat (2003), p. 1013; Huse (2005), pp. 43 ff.; c.f. Boyd (1990), pp. 419ff. Makadok (2001), pp.
389ff.; good corporate governance must be adapted to changes in the environment, for more information
refer to Hillman et al. (2000), pp. 241ff.; Boeker/Goodstein (1991), pp. 805ff.
278
Barney et al. (2001), p. 632; indirectly Barney/Hansen (1994), p. 188 also considers corporate governance
as a source of competitive advantage; Collis (1994), p. 143 states that organisational capabilities — which
are partly determined by corporate governance — are a valuable resource of competitive advantage;
furthermore this is a perspective often found in research on the corporate governance of family firms, e. g.
Carney (2005), pp. 249 ff.
279
Acquaah (2003), p. 76.
280
281
Porter (2004), pp. 215ff.; Fiet (1995), p. 555; Küting (2000a), p. 597
282
Eisenhardt/Martin, pp. 1106 and 1111.
60
activities.283 Accordingly, good decision making is required to gain a competitive
advantage, so corporate governance is very important. Empirical evidence demon-
strates that knowledge-based resources — and corporate governance quality
depends largely on knowledge and abilities — are particularly important for a
company’s success in dynamic and unpredictable environments.284
This shows that corporate governance is very valuable for the successful development
of growth companies that very often operate in dynamic markets.
Rare: To confer a competitive advantage, good corporate governance must be rare

among growth companies. Growth companies are generally young285, and their
corporate governance structures are not well established because they were of less
importance when the companies were very small, and the ownership and the
management were not separated. Moreover, the scarce resources of growth compa-
nies might also be an obstacle to implementing good corporate governance. This is,
on one hand, due to the limited experiences and skills of the companies’ managers
and, on the other hand, due to the limited possibilities for investing in further
resources.286
The limited elaboration of growth companies’ corporate governance is clearly shown

in regard to the quality of the composition and the work of boards. The members of
boards in growth companies might not be selected based on their capabilities but based
on their relations to the managers, who often have a say in the selection due to their
ownership. The supply of information to board members is also often not optimal as
adequate information systems are not in place.287 In some growth companies, there are
not even formal board meetings at all because managers do not see the need for
them.288
283
Eisenhardt/Martin (2000), p. 1106; Teece et al. (1997), p. 516; Judge/Miller (1991), pp. 449ff.; c.f.
Aragon-Correa/Sharma (2003), pp. 71ff.
284
Miller/Shamsie (1996), pp. 538ff.
285
This holds also for later stage growth companies like MBIs and MBOs where the financed company is
generally also a relatively new entity even if its origins are in an older company. The ownership and
management structures are still new in these cases.
286
Riekert (2004), p. 57; Talaulicar et al. (2001), pp. 511ff.; Boeker/Wiltbank (2005), pp. 123ff.
287
Grundei/Talaulicar (2001), pp. 194ff.; Talaulicar et al. (2003), p. 516ff.
288
Andersson/Gunnarsson (1999) according to Gabrielsson/Huse (2002), pp. 139ff.
61
These examples show that corporate governance quality is generally considered to be
rather poor among growth companies, so such companies with good corporate gover-
nance are rare.
Imperfectly imitable/substitutable: In highly dynamic markets, dynamic

capabilities might be causally ambiguous. Because they have to be constantly
reconfigured to match market conditions, their effectiveness is difficult to evaluate.
This makes it difficult to derive causality. Even successful managers might not
know why their dynamic capabilities are successful.289
Additionally, corporate governance is also affected by social complexity because its

effectiveness is determined by formal and informal structures such as relations
between managers and board members.290 That means that the effectiveness depends,
for example, largely on the collaboration of managers and board members, which
cannot be easily influenced.
Causal ambiguity and social complexity make corporate governance difficult to

imitate. Apart from this, corporate governance cannot be substituted. Although compe-
titors might substitute particular corporate governance elements, it is assumed that
there is no substitute for corporate governance because it is the basis of a company.
Nonetheless, the sustainability of a competitive advantage built on corporate
governance is questionable because its adequacy depends on a company’s situation.
Therefore, the adequacy of specific corporate governance structures and processes
might change rapidly in dynamic markets.
However, it is shown that good corporate governance is both valuable for growth
companies and relatively rare. Corporate governance is an important basis for the
competitiveness of growth companies if they have structures and processes that enable
them to make well-informed decisions. The dynamic resource-based view focuses on
the advice function of corporate governance because it largely determines the resour-
ces needed for decision making capacity.
289
290
C.f. Hambrick (1987), pp. 88 ff.; Barney (1991), p. 110.
62
4 Relationship between Venture Capital, Corporate
Governance and Firm Value
This chapter builds a theoretical framework for the relationship between venture
capital, corporate governance and firm value on the basis of the two perspectives intro-
duced in chapter three. The four aspects that are expected to have the greatest
importance in this relationship, based on the literature review, are analysed. First, the
reasons for the venture capitalists’ influence on the corporate governance of portfolio
companies are explained. Thereafter, the expected effects of the influence on corporate
governance quality are described. This is followed by a description of the abilities that
should determine the venture capitalists’ impact. In the end, the effects of good corpo-
rate governance on growth companies' firm value are determined.291 The specific
hypotheses are derived in the following.292
4.1 Reasons for Venture Capitalists’ Influence on Corporate

Governance
Venture capitalists’ primary reason for influencing corporate governance should be to
improve the return on their investment. Because the influence is time and cost consu-
ming, they should expect the benefits to be greater than the costs. The benefits might
arise from a reduction of risk or costs on one hand or from value creation on the other
hand. Correspondingly, the two underlying theories differ in their explanation of
venture capitalists’ influence. Whereas agency theory considers costs from agency
problems as an impetus, the dynamic resource-based view sees good corporate gover-
nance as a basis from which to build a competitive advantage and create value.293
Besides this, a venture capitalist might also influence the corporate governance of the
portfolio companies to attract interest from investors or because of a planned exit from
an investment to comply with mandatory corporate governance codes.
291
For a literature review on corporate governance in growth companies, refer to Daily et al. (2002), pp.
387ff.
292
An overview of all hypotheses is given in 5.1.
293
Lynall et al. (2003), pp. 417ff.; c.f. for the controversy between the control and collaboration roles of
corporate governance, refer to Sundaramaurthy/Lewis (2003), pp. 397ff.
63
4.1.1 Risk Reduction
According to the agency theory, the reason for implementing efficient corporate
governance is the risk of agency problems and consequential value losses.294 This is
because the great information asymmetries that exist in the relationship between a
venture capitalist and the managers of a portfolio company increase the risk of oppor-
tunistic behaviour by the managers, which in turn could lead to value losses for the
venture capitalists.295 The need for good corporate governance depends, as explained in
section 3.1.2.2, on the level of the associated agency and business risk. Agency risk
increases the opportunities for managers to act opportunistically, and business risk
raises the probability that they would do so and makes the consequences more severe.
Consequently, venture capitalists should influence the corporate governance of their
portfolio companies if the associated agency and business risks are high. This is
proven empirically by BARNEY ET AL., who found that high agency and business
risk are associated with venture capitalists’ use of more elaborate corporate gover-
nance structures and processes to monitor and bond the managers of portfolio
companies.296
4.1.1.1 Extent of Agency Risk

Agency risk depends on the danger of managerial deviation from value maximisation.
The greater it is, the greater is the need for outside oversight of a firm. Therefore,
agency risk increases the need for venture capitalist involvement in portfolio
companies’ corporate governance.297 Venture capitalists, as particularly important
supervisors of the management in growth companies, should be involved more
strongly in boards when the agency risk is great.298
SAPIENZA/GUPTA prove this empirically by analysing the relationship between

agency risk and the extent of interaction between venture capitalists and the managers
of portfolio companies. They find support for the hypothesis that the interaction is
more frequent in the case of low goal congruence between the venture capitalists and
the managers as well as in the case of limited start-up experience for the CEO of a
294
Barney et al. (1989), pp. 64ff.
295
Leland/Pyle (1977), p. 371.
296
297
Sapienza et al. (1996), p. 445; Fama/Jensen (1983), pp. 301ff.; Sapienza/Gupta (1994), p. 1620; Van den
Berghe/Levrau (2002), p. 126.
298
Lerner (1995), p. 302.
64
portfolio company. Furthermore, their results indicate that the interactions will be
more frequent in the case of greater uncertainty due to an early development stage and
a high degree of innovativeness in the portfolio company.299 KAPLAN/STRÖMBERG
show that a higher internal risk in a portfolio company leads to a higher level of
venture capitalist control.300 An example for this is the case of executive officer
turnover. GOMPERS/LERNER show empirically that venture capitalists increase the
number of their board seats significantly more in portfolio companies with CEO
succession than in companies without CEO succession. This is also true for other out-
sides, but to a lesser extent.301
BARNEY ET AL. also show empirically a positive relationship between high agency
risk and venture capitalists’ monitoring activities. They use variables such as the
number of years a CEO has been associated with a portfolio company, the percentage
of initial financing by the CEO and the percentage of equity held by the company’s
employees302 that indicate low agency risk and prove that these are negatively related
to the ownership share of the venture capitalists, which as has been shown before, is an
indicator for venture capitalists’ influence and hence also for their monitoring acti-
vities.303 A similar approach is taken by FREDRISEN/KLOFSTEN who analyse the
extent of venture capitalists’ influence on the governance of portfolio companies in
relation to associated risk. In particular, a board of directors with weak competence —
which might increase the agency risk — has a strong effect on the venture capitalists’
influence.304
Based on the theoretical and empirical evidence, it can be expected that venture
capitalists recognise the need for good corporate governance and hence for their influ-
ence by assessing the agency risk associated with a particular investment.
299
Sapienza/Gupta (1994), pp. 1628ff.
300
Kaplan/Strömberg (2004), p. 2203.
301
Gompers/Lerner (2002), pp. 176ff.
302
Managerial ownership is here seen as an instrument to align the interests of the owners and the managers
of a company and is therefore considered as a substitute to monitoring by the owners. Empirical evidence
for this comes from SAPIENZA/GUPTA who could not support the hypothesis that the interaction
between the VC-investor and the portfolio company is particularly strong in companies with a low level
of management ownership; see Sapienza/Gupta (1994), p. 1628.
303
Barney et al. (1989), pp. 66ff.; Barney et al. (1996a), pp. 100ff.
304
Fredriksen/Klofsten (2001), pp. 213ff., their two types of risk “agency risk” and “conformity risk” are
here considered to be agency risks becuase they both stand for problems that arise because of information
asymmetries between the venture capitalist and the management of the portfolio company.
65
4.1.1.2 Extent of Business Risk
Business risk is considered to influence the need for good corporate governance.305 The
higher the business risk — indicated by the level of profitability — the greater is the
risk for venture capitalists that their investments fail.306
Empirical findings from BARNEY ET AL. support this as they indicate that the
ownership share and the number of board seats of venture capitalists — which
measures venture capitalists’ influence — are both negatively correlated with the
profitability of a portfolio company.307 HIGASHIDE/BIRLEY also found that venture
capitalists’ involvement in portfolio companies increases when they perceive the port-
folio companies’ performance to be unsatisfactory. In that case, they might feel that
they can make an effective contribution to the companies’ development.308
Further empirical evidence exists for specific elements of business risk. In the
following, the findings for three important elements of business risk are presented,
more precisely for two internal and one external element.
Business risk arises from the innovations associated with the products and processes of
a company. The higher the degree of innovation is, the greater are the uncertainties in
regard to the technical feasibility of a product, its novelty and its acceptance by the
market.309 This can have a negative impact on the company’s profitability and by this
increase its business risk. This is reflected in a close interaction between venture capi-
talists and managers, as SAPIENZA/GUPTA show empirically.310
The second element is the quality of the managers of a portfolio company. The less
experience and fewer capabilities managers of portfolio companies have, the greater is
the risk that they make decisions that reduce the company’s profitability. Accordingly,
the need for venture capitalists to bond and monitor the managers rises. SAPIENZA/
GUPTA, for example, prove empirically that in companies in which the CEO has little
start-up experience, the interaction between the VC-investor and the portfolio
company will be more frequent than in other companies.311 BAKER/GOMPERS
305
Galbraith (1973); Sapienza/Gupta (1994), p. 1620
306
Barney et al. (1989), p. 65; Barney et al. (1996a), pp. 100ff.
307
Barney et al. (1989), p. 67.
308
Higashide/Birley (2002), p. 78.
309
Sapienza/Gupta (1994), pp. 1622ff.
310
Sapienza/Gupta (1994), p. 1629.
311
Sapienza/Gupta (1994), p. 1628.
66
similarly found that the number of board seats taken by venture capitalists decreases as
the tenure of the CEO of a company increases.312 In contrast to this, SAPIENZA ET
AL. came to a different result in another study. Their results indicate that a greater
start-up experience of the managers leads to more interaction between them and the
venture capitalists. A possible explanation might be that the managers in that case are
more prepared to accept advice from the investors.313 These mixed results are also
supported by the findings of two studies on the relationship between industry risk and
venture capitalists’ involvement. Analyses from MAC MILLAN ET AL. and from
SAPIENZA ET AL. have shown that the industry experience of the managers does not
influence the extent of involvement of venture capitalists.314
Finally, external risk might also increase the business risk of a company because it
makes it more difficult for companies to become and stay profitable. Empirical evi-
dence from KAPLAN/STRÖMBERG proves that higher external risk is related to
higher control by venture capitalists, for example, in the form of an increase in their
liquidation rights and tighter staging, which means that the time between two finan-
cing rounds is shorter.315
The partially mixed results show that the relationship between business risk and the
involvement of venture capitalists in the corporate governance of portfolio companies
is not simple. Even though portfolio companies are generally affected with high
business risk, it could be expected that venture capitalists should become more invol-
ved in those companies that face a relatively strong business risk, at least until a suc-
cessful outcome is considered probable. Therefore, it is expected that venture capita-
lists recognise the level of business risk in a company that determines the need for
good corporate governance and adapt their influence accordingly.
In his analyses comparing the behaviour of venture capitalists and business angels in
relation to their risk assessment, FIET found that venture capitalists consider business
risk more important than agency risk. That means that they evaluate a potential invest-
ment more on the basis of business risk than of agency risk. A possible explanation
might be that venture capitalists are specialists in dealing with agency problems so that
312
Baker/Gompers (2003), p. 587.
313
Sapienza et al. (1996), pp. 439ff.
314
Macmillan et al. (1988), pp. 27ff.; Sapienza et al. (1996), pp. 439ff.; Ruppen (2001), p. 183.
315
67
business risk is the greater hazard.316 This explanation is supported by a later analysis
of FIET/HELLRIEGEL who found that venture capitalists control for business risk
primarily before an investment is made and control for agency risk primarily after an
investment decision.317 This means that business risk should have a greater impact on
contractual arrangements and agency risk should have a bigger impact on mechanisms
put into action during the investment.
The theoretical and empirical analyses indicate that the associated agency and business
risks explain the strength of venture capitalists' influence on the corporate governance
of their portfolio companies.
H1.1: The greater the agency and business risks associated with an investment, the
greater is the venture capitalists’ influence on the corporate governance.
According to agency theory, bonding and monitoring are the two ways to reduce the
risk of opportunistic behaviour by management and value losses for venture capitalists.
Consequently, the corporate governance elements that fulfil a bonding or monitoring
function should be influenced by agency risk. First, in regard to management are the
assessment, selection, compensation and bonding of the managers. Second, in regard
to the board (or supervisory board in a two-tier system) are the composition and the
work. Third is the reporting discipline.
The requirements for the managers of growth companies are demanding and fast
changing. As the companies are generally centred on the managers, they determine the
companies’ success in a great measure. Therefore, their regular assessment is of high
importance. This is particularly true in the case of high agency and business risk as
moral hazard is likely to occur, which might have negative effects on the company’s
development. Hence, it can be expected that venture capitalists strongly influence the
assessment of managers if the associated agency and business risks are great.
H1.1.1: The greater the agency and business risks associated with an investment, the
greater is the venture capitalists’ influence on the assessment of the managers.
The selection of the managers is a hazard to adverse selection because the venture
capitalist does not know about all the candidates’ characteristics. If the typical high
316
Fiet (1995), pp. 564ff.; Fiet (1991), p. 76.
317
Fiet/Hellriegel (1995), p. 36.
68
dependency on the management in growth companies is combined with a high risk of
opportunistic behaviour and a high risk of severe consequences for opportunistic beha-
viour, the venture capitalists should closely monitor and even support the selection
process of the managers.
greater is the venture capitalists’ influence on the selection of the managers.
According to the agency theory, opportunistic behaviour can be reduced by aligning

the interests of venture capitalists and the portfolio companies’ managers by giving the
managers appropriate incentives. This is particularly important if the managers’
abilities and the likelihood of opportunistic behaviour, as well as the potential negative
consequences, are great.
greater is the venture capitalists’ influence on the compensation of the managers.
Finally, the risk that managers will hold up the future development of the company by
leaving it is also more likely in the case of high agency risk. Moreover, the negative
consequences might be very severe if the business risk is high. Hence, it can be
expected that the venture capitalists strongly influence the bonding of portfolio
companies’ managers in the case of high agency and business risks.
greater is the venture capitalists’ influence on the bonding of the portfolio companies’
managers.
Agency theory focuses on both, the structure and the work of boards: Independence is,
according to agency theory, a prerequisite for the effectiveness of boards as it gives the
members an incentive to monitor the managers. Therefore, venture capitalists are
expected to influence the composition of the board in cases of strong agency and
business risks.
greater is the venture capitalists’ influence on the composition of the board.
Moreover, agency theory also attaches great importance to the work of the board. To
monitor and bond the managers of the portfolio companies, the board has to meet
69
regularly and be involved in all important decisions of the company, particularly in
cases of high agency and business risk.
greater is the venture capitalists' influence on the work of the board.
According to agency theory, the venture capitalists also influence the portfolio
companies' reporting discipline. Interventions to prevent value losses require that they
are well informed about the current development of the portfolio company. Regular
reporting provides timely information, which is particularly important in cases of high
agency and business risk.
greater is the venture capitalists’ influence on the frequency of reporting.
4.1.2 Value Creation

According to the dynamic resource-based view, the reason for the influence of venture
capitalists on the corporate governance of portfolio companies is value creation.318
Implementing good corporate governance in growth companies can lead to a compe-
titive advantage and thereby create value. Good corporate governance is a valuable
resource for growth companies, as was detailed in section 3.2.2.2. Furthermore, due to
its rarity among those companies, good corporate governance can lead to a competitive
advantage. Hence, venture capitalists might influence their portfolio companies’
corporate governance in order to improve the decision making capacity, which should
increase the companies’ value.
Some studies support the notion that the reason for venture capitalists’ influence is not
solely the reduction of agency problems. Venture capitalists might exert strong
influence in companies despite low agency and business risks where they expect to be
able to create value instead. The findings of FREDRIKSEN/KLOFSTEN show that
venture capitalists increase their influence on portfolio companies in the absence of
agency risk. The analysis showed a positive relation between the venture capitalists’
trust in the managers of the portfolio company — a situation with low agency risk —
and the frequency of interaction, although this relationship was only weakly
318
This corresponds to the general assumption that venture capitalists’ influence is aimed at value creation,
refer, e.g., to Manigart et al. (2000).
70
significant.319 Thus, venture capitalists might have other motivations than risk- and
loss-reduction. Value creation is the reason behind a broad range of support activities
that venture capitalists should contribute to the professionalisation of portfolio
companies.320
Due to the fact that the influence on portfolio companies is time and cost consuming,
venture capitalists might have to focus on a limited number of companies to influence.
Generally, venture capitalists build portfolios of companies, of which only one or two
companies out of ten become really successful whereas most of the other investments
fail. So the success of the investment portfolio depends largely on the success of single
promising investments.321 Correspondingly, it might be worthwhile to focus on those
companies that are likely to be successful.322 In regard to their influence on corporate
governance, venture capitalists should accordingly concentrate on companies that have
the potential to build a competitive advantage from their corporate governance.
The dynamic resource-based view considers resource endowment a condition for the
achievement of competitive advantages.323 As introduced in section 3.2.1, the dynamic
resource-based view assumes that resources can be acquired or developed despite the
existing path dependency of resources.324 HELFAT/PETERAF explain capability
lifecycles, i.e., the development of capabilities from founding to maturity.325 Following
this view, the resources and capabilities endowments present at founding set the stage
for their further development. Thus, the endowment at founding provides initial
sources of heterogeneity.326 Consequently, the initial corporate governance is an impor-
tant determinant of a company’s potential to build a competitive advantage on its
Consequently, venture capitalists might select the companies on which to exert

stronger influence according to the companies’ initial corporate governance quality.
The better the initial corporate governance, the stronger the venture capitalists’
influence might be.
319
Fredriksen/Klofsten (2001), p. 214; they name this governance supporting concept “coalition risk”.
320
321
Ellis (2003), p. 54.
322
Dimov/Shepherd (2005) refer to “home-runs”.
323
324
Path dependency of corporate governance is shown by Bebchuk/Roe (1999) at the national level and by
Beckman/Burton (2004) for management of growth companies.
325
Helfat/Peteraf (2003), pp. 997ff.
326
71
H1.2: The better the initial corporate governance quality, the greater is the venture
capitalists’ influence on the corporate governance.
The dynamic resource-based view puts most emphasis on the corporate governance
elements that have an advice function for the company and thereby increase the
companies’ resource endowment required for management and control. Those ele-
ments include management selection and the composition and work of the board.
The crucial role of the managers for the development of a portfolio company makes
the managers’ selection process highly important and the managers one of the core
resources of a growth company. Therefore, the selection of new managers is a very
critical task that requires an effective and efficient process. Venture capitalists, with
their specific experiences, might be able to add their competence, experiences and
capabilities to improve the managers’ selection process. Venture capitalists might
focus their influence on companies where their contribution can have the greatest
impact and might, according to the dynamic resource-based view, influence the
managers’ selection more strongly in companies that already have high-quality
corporate governance. This is because the managers should either be more willing or
should be more forced to accept the advice in those companies.
H1.2.1: The better the initial corporate governance quality, the greater is the venture
capitalists’ influence on the selection process of new managers.
There are also two aspects of the board that emphasise the advising function of
corporate governance in portfolio companies: This theoretic perspective places empha-
sis on the advice role of the board, which is more relevant in companies that have good
corporate governance because that might increase the impact of the advice. To carry
out the advice role, the board needs qualified members. Hence, it can be expected that
venture capitalists influence the composition of the board more strongly if the initial
corporate governance quality is high.
H.1.2.2: The better the initial corporate governance quality, the greater is the venture
capitalists’ influence on the composition of the board.
The advice function of the board can only be fulfilled when the board is involved in
the decision making of the portfolio company. Hence, it is necessary that the board
address strategic decisions. Venture capitalists might focus their influence on
72
companies where they consider strategic advice particularly helpful, which might be
the case of companies with good corporate governance.
H1.2.3: The better the initial corporate governance quality, the greater is the venture
capitalists’ influence on the work of the board.
4.1.3 Exit Preparation

In the case of a planned exit, venture capitalists might also strengthen their influence
on the portfolio companies to ensure the successful sale of the company.327 This might
also influence the companies’ corporate governance. Whereas there are no great
effects to be expected from a sale-back, a secondary-sale or a trade sale, the prepa-
ration for an initial public offering (IPO) might lead to changes in the corporate gover-
nance because it greatly influences the success of an IPO.328 The reasons for this are
twofold. On one hand, public companies in many countries have to comply with
corporate governance codes that are implemented either by the national legislature or
the stock exchange.329 Therefore, companies that seek approval for a public issuance
have to comply with or at least align to those codes. Venture capitalists that want to
ensure the success of a public offering might influence their companies in order to
fulfil the requirements. However, this does not necessarily strengthen the monitoring,
bonding or advice function of corporate governance. On the other hand, the success of
an IPO depends largely on interest from investors. Growth companies often lack a high
awareness among the public because of their short history and limited size. Connecting
well-known names to the company could arouse the public interest. The investors’
perception of the board prestige signals organisational legitimacy and could thereby
reduce the liability of market newness. This should support a company’s chances to
realise a successful IPO.330 Venture capitalists might try to involve reputable people in
the boards in order to send a positive signal to the market and thereby contribute to the
success of the IPO.
Accordingly, it can be expected that venture capitalists increase their influence on the
corporate governance of portfolio companies when a public exit is prepared.
327
Certo et al. (2001), pp. 33ff.; Certo (2003), pp. 432ff.; Hochberg (2002), pp. 30 ff.
328
Hartzell et al. (2004), p. 26.
329
Burton et al. (2004), pp. 356ff.; Weimer/Pape (1999); Temorale/Ismann (1999), pp. 263ff.
330
Burton et al. (2004), pp. 356ff.; Certo (2003), p. 439; Deutsche/Ross (2003), pp. 1006ff.; c.f.
Welbourne/Cyr (1999), pp. 616ff.
73
H1.3: Before a potential public exit, venture capitalists increase their influence on the
corporate governance of portfolio companies.
They focus particularly on the compliance with corporate governance codes and bring
in well-known board members.
H1.3.1: Before a potential public exit, it is more probable that the portfolio companies
comply with corporate governance codes.
H1.3.2: Before a potential public exit, it is more probable that the portfolio companies
have board members with experience in listed companies.
4.1.4 Development of Reasons for Influence

The three reasons for the influence of venture capitalists on the corporate governance
of portfolio companies might all be observed in practice but might change over the
development of an investment. Preparation for an exit should obviously be a strong
reason only before a potential exit. The explanatory power of the two other reasons for
influence might also depend on time. Venture capitalists might base their influence on
changing criteria over the life of an investment. Given the maximisation of the return
on investment as the main goal of venture capitalists, the focus might change from risk
and loss reduction to value creation over time.331 The two perspectives correspond to
two opposing hypotheses, the “trouble-shooting strategy” and the “home-run strategy”.
Whereas the first hypothesis indicates that the influence of venture capitalists on
portfolio companies is increased when the business is performing badly,332 the latter
says that the investors put more effort into companies that are performing well because
it is more rewarding.333 This is supported by an analysis by SAPIENZA ET AL. that
found that venture capitalists add more value to companies that are performing well
than they do to those that are performing badly.334
The agency theory’s argument that agency and business risk are important deter-
minants of venture capitalists’ influence on the corporate governance of portfolio
331
The value creation aspect also requires the corporate governance to fulfil different functions at different
life cycle phases; for more information refer to Lynall et al. (2003), pp. 421ff.
332
Van den Berghe/Levrau (2002), p. 127.
333
Sapienza et al. (1996), pp. 458ff.; Sapienza/Timmons (1989), pp. 245ff.
334
Sapienza et al. (1996), p. 462.
74
companies might be more relevant in early financing rounds.335 The real potential of an
investment can hardly be predicted at that time, so venture capitalists might try to
secure all investments and make efforts to reduce agency problems in all portfolio
companies. In some cases, this might not improve the situation so that at a later finan-
cing round, the venture capitalists might have given up their goal to reduce the risk. In
that case, agency and business risk might not predict venture capitalists’ influence
anymore. This perspective is supported by the empirical findings that show that the
extent of involvement of venture capitalists is higher in early stage companies that in
late-stage companies because the degree of uncertainty is higher.336
In contrast to this, the explanation of the dynamic resource-based view might be more
relevant in later financing rounds as venture capitalists would then be better able to
assess the corporate governance of the portfolio companies and decide which portfolio
company has the potential to build a competitive advantage on its corporate gover-
nance. Consequently, it can be expected that corporate governance quality is a better
predictor of venture capitalists’ influence in later financing rounds.
Hence, it is expected that the reasons for venture capitalists' influence change from
agency and business risk in early financing rounds to the quality of corporate
governance at later financing rounds.
H1.4: Agency and business risks have a stronger impact on venture capitalists’
influence on the corporate governance of portfolio companies at earlier financing
rounds than at later financing rounds.
Finally, it should be remarked that the venture capitalists’ influence on corporate

governance because of a planned exit should, as a matter of course, occur in the prepa-
ration process for an IPO.
According to the underlying theories, there are three different reasons for venture
capitalists’ influence on corporate governance that might change over time. Hence, the
reasons and corresponding hypotheses can either be substitutable or complementary.
Figure 12 illustrates the expected relationship between the reasons and the venture
335
It should be noted that there is also the proposition that the dominant corporate governance function
depends rather on the CEO tenure than on the investment of a company and that the advice function
dominates in the beginning whereas the control function becomes more important in later CEO tenure; for
more information refer to Shen (2003), pp. 466ff.
336
Gorman/Sahlman (1989), p. 245; Sapienza et al. (1996), p. 459, Elango et al. (1995), p. 164.
75
capitalists' influence on the corporate governance of portfolio companies. The impact
of this influence is discussed in the next section.
Reason
Agency
theory
Risk
reduction Venture
Capitalist's
Influence
Resource-
based view
H1
Intensity
Value
creation
CG-Elements
Exit
preparation
IPO-
preparation
Figure 12: Relationship between reasons and venture capitalists' influence
4.2 Effects of Venture Capitalists’ Influence on Corporate

Governance
In this section, the expected effects of the venture capitalists influence on the corporate
governance of portfolio companies are explained. It is structured along the six corpo-
rate governance elements related to the management, the board and the reporting of
companies. For every element, the expected effects are first derived from theory before
empirical findings are presented. In the end, findings on the effects of venture
capitalists’ influence on the portfolio companies’ performance or value are given,
where available.
The basic hypothesis of the following section is:
H2: The venture capitalists' influence has an impact on the portfolio companies'
4.2.1 Management
4.2.1.1 Assessment and Selection of Managers
As explained in section 3.1.2.1, managers are particularly important for the realization
of growth companies’ value potential. Therefore, the assessment of managers, the
76
potentially required replacement of managers, and the selection of new managers are
crucial for the success of venture capitalists’ investments.
Agency theory and the dynamic resource-based view both consider these corporate
governance elements as important, but they focus on different aspects. According to
agency theory, the shareholders have to closely monitor the managers and push for a
replacement should the current managers not be effective. This requires frequent
assessment of the managers, which can be done by the board or at the shareholder’s
meeting. If managers are unable to fully generate the value of the business, they should
be replaced.337 When new managers are selected, the shareholders should again closely
monitor this process so that no decision is made against their interest. Accordingly,
good corporate governance means, in this context, that the shareholders regularly
assess the appropriateness of the managers, replace managers if needed and closely
monitor the selection process of new managers.338 Venture capitalists, as blockholders,
should have the power to fulfil this monitoring role and the power to push for changes
in the current management team, if required. Agency theory asks the shareholders to
maintain comprehensive decision rights in the contracting phase in order to reduce the
risk of moral hazard, which should give the shareholders the rights they need. So,
venture capitalists should be able to improve management assessment and selection.
The dynamic resource-based view focuses more on the advisory role of the venture
capitalist in the process of selecting new managers.339 According to this, the outcome
of the managers’ selection process depends on the effectiveness of the process. Hence,
good corporate governance means that the decisions are made well informed, i.e., a
broad range of candidates is taken into account and the decision is made by people
with the necessary knowledge. Venture capitalists should be able to improve the selec-
tion process because they have, on one hand, the experience of having done this
process times before and, on the other hand, a network of specialists for the selection
of managers as well as a network of possible candidates.340 Consequently, they should
have knowledge and resources that can contribute to the effectiveness of the managers’
selection.
337
Hambrick (1987), pp. 89ff.
338
C.f. Hillman/Dalziel (2003), p. 385.
339
C.f. Hillman/Dalziel (2003), p. 386.
340
Hellmann/Puri (2002), pp. 177ff.
77
Empirically it is shown that venture capitalists are active in the assessment,
replacement and selection of members of the management team. KAPLAN/
STRÖMBERG found that more than half of the investors in their American sample
was active either before or after their investment had been made.341 Another study
indicates that this influence on managers is of high importance for venture capitalists.
The analysis of FREDERIKSEN ET AL. looked at the perceived influence of the
venture capitalists in the view of the CEOs of the portfolio companies. They found that
questions concerning the CEO position, and more generally the personnel, were
among the areas that are most influenced by venture capitalists.342 In particular, the
replacement of managers has been analysed by several researchers. They show that
venture capitalists seem to be particularly focussed in replacing the founder with a
professional manager as CEO. Venture capitalists often argue that a professional top
management team adds value to the portfolio company and that founders were prone
to pursue actions in their own interest rather the company’s interest.343 LERNER found
that the representation of venture capitalists at portfolio companies’ boards increases
around the time of a replacement of the CEO. According to his analysis, venture
capitalists added 1,75 board members between financing rounds when the CEO was
replaced, compared to an average increase of only 0,24 members between rounds
when the CEO was not replaced.344 The analysis by POLLOCK ET AL. supports this
and shows that the number of IPOs with a founder-CEO is significantly higher in
companies that are not venture capital-backed than in those that are.345 Similar results
come from CERTO ET AL. who consider this a consequence of weak negotiations
between founder-CEOs and investment banks when the issue price of the shares is to
be determined.346 That means a reason for the replacement might be the weak
management competence of founder CEOs. These results are a strong indication that
venture capitalists are active in the replacement of managers.
Venture capitalists are also actively involved in the selection process of new managers.
The analysis of HELLMANN/PURI provides support for this as it shows that the
selection process tends to be more professional in venture capital-backed firms than in
other growth companies. Venture capital-backed firms make significantly greater use
341
342
Frederiksen et al. (1990), p. 259.
343
Hellmann (1998), p. 57; Pollock et al. (2005), p. 1; Martens et al. (2005), p. 1.
344
Lerner (1995), p. 310.
345
Pollock et al. (2005), p. 8.
346
Certo et al. (2001), p. 655.
78
of business and professional contacts when searching for new personnel for functional
and managerial positions. This might be related to the venture capitalists’ network as
well as to other sources of contacts.347 Similarly, ROSENSTEIN found that the
influence on the recruitment of CEOs by venture capitalists’ board members is
perceived as very valuable by the managers of portfolio companies.348 This indicates
that venture capitalists also positively influence the selection of new managers.
Some of the studies also tried to find a relation between the venture capitalists’
influence on these corporate governance elements and the portfolio companies’
performance. POLLOCK ET AL. and MARTENS ET AL. found that replacing a
founder-CEO has a significant and positive impact on a firm’s ability to raise capital in
the IPO process.349 However, one of the two analyses also provides evidence that a
founder who stays in the company as a member of the management team or the board
also has a positive influence on the company’s valuation at the time of the IPO.350 In
contrast to this, the findings of MARTENS ET AL. indicate that the long-term success,
measured by the probability of not being delisted, is greater for companies with non-
founder-CEOs compared to those with founder-CEOs. Additionally these delistings
take place earlier in the case of professional managers as CEOs.351 But it is questio-
nable here whether low risk of delisting is a good measure for long-term success
because delisting as a result of an acquisition by another firm is not necessarily
negative for shareholders or the company.
The theoretical and empirical findings indicate that venture capitalists should improve
the assessment and selection of the portfolio companies’ managers and should, if
required, replace managers.
H2.1: The venture capitalists' influence has a positive impact on the assessment and
selection of managers.
Consequently, it can be expected that they assess management regularly and

effectively.
347
Hellmann/Puri (2002), p. 177.
348
Rosenstein et al. (1993), p. 105.
349
Pollock et al. (2005), p. 8; Martens et al. (2005), p. 16.
350
Pollock et al. (2005), p. 8; Martens et al. (2005), pp. 16ff.; they could not support their comparable
hypotheses; they found insignificant support for the higher IPO value when the CEO remained a member
of the management team and even a negative relationship when the CEO became a board member.
351
Martens et al. (2005), p 18.
79
H2.1.1: The stronger the venture capitalists’ influence, the more likely managers are to
be assessed.
H2.1.2: The stronger the venture capitalists’ influence, the more efficient is the
assessment of the management.
The assessment of the management could disclose deficits in the current management,
which should lead to the replacement of managers.
H2.1.3: The stronger the venture capitalists’ influence, the more likely managers are to
be replaced.
When selecting new managers, the venture capitalists’ influence should make the
selection process more efficient and effective.
H2.1.4: The stronger the venture capitalists’ influence, the better is the managers'
selection process.
4.2.1.2 Bonding of Managers

As explained before, the managers of growth companies play a particularly important
role because they have specific knowledge and capabilities that are necessary to
exploit the growth potential of the company. The high importance of the managers not
only requires having appropriate managers but also holding them in the company.
If managers with specific knowledge and capabilities leave a company, it could be a

hazard for the company’s future success. This can affect a portfolio company in two
ways. These managers take with them assets, skills and knowledge that might be
crucial for the portfolio company. Additionally, they might increase the competition
for the company by using those resources in another company.352 According to agency
theory, shareholders should reduce this risk by effectively bonding the managers to the
company. They should be forced or have an incentive to stay in the company.353 So
effective bonding is considered to be in the interest of the investors and therefore seen
as good corporate governance. Venture capitalists should, as blockholders, have the
power to negotiate adequate bonding measures with the founders during contracting so
that it can be expected that they contribute to effective bonding.
352
353
Denis (2001), pp. 195ff.
80
Common bonding instruments are stock option programmes and non-compete clauses.
Stock option programmes generally have vesting periods, which means that the
managers can take full advantage of the options only after a certain time. Non-compete
clauses forbid managers from working for a competitor for some time after they leave
the portfolio company.354
KAPLAN/STRÖMBERG found in their empirical study that venture capitalists adopt

corresponding measures to prevent managers from leaving the company. Many
venture capitalists give managers an incentive to stay in the company by introducing
shares for the managers that vest over time. Should the management leave the compa-
ny before a defined date, the shares that are not vested yet can be bought back by the
company for a low value. Additionally, they show that most venture capitalists also
introduce non-compete clauses that bar managers from working for a competitor after
they leave the company.355 They also found that contracts between venture capitalists
and portfolio companies can be contingent on continued employment,356 which is also
a sign of the influence of investors on the bonding of managers.
According to this analysis, venture capitalists obviously realise the necessity of

effective bonding of the managers because they use non-compete clauses and stock
options as bonding instruments. So, it can be expected that they use their influence to
improve the bonding of managers and thereby improve corporate governance.
H2.2: Venture capitalists' influence has a positive impact on the bonding of managers.
4.2.1.3 Compensation of Managers

Apart from the selection of adequate managers and bonding them to the company, it is
also crucial for managers’ effectiveness that they be compensated adequately. The
compensation structure should provide them with incentives to act in the shareholders’
interest but should also take the company’s resources into account.
The compensation of managers is another corporate governance element that could,

according to agency theory, reduce agency problems. Managerial compensation should
meet two requirements. On one hand, it is an important instrument to align the goals of
the managers and the investors. Adequate incentive structures for the managers could
354
Salop/Salop (1976), pp. 620ff.
355
356
81
reduce the risk of opportunistic behaviour.357 The managers should have an incentive to
pursue mid- and long-term goals that correspond to the exploitation of the full
potential of growth companies. Correspondingly, a great part of the compensation of
the managers should depend on the future success of the portfolio companies.358 Instru-
ments for the alignment of interests are mid- and long-term variable compensation
parts such as options and managerial ownership because they allow managers to parti-
cipate in the long-term development of the company.359 But it is important to note that
the associated managerial ownership can also lead to negative effects as the managers
gain control.360
On the other hand, the managers’ compensation must be seen on the basis of the scarce
financial resources of growth companies. Therefore, the compensation, and in
particular the cash payments, should not be too high for the resources of the company.
This affects both the absolute level of the managers’ compensation and the balance
between its elements. Stock options and managerial ownership could be used to
substitute for cash payments, either fixed or variable payments. They are a compa-
ratively cheap method of payment if the “perceived costs” rather than the economic
costs are considered. The economic cost is what an outside investor would be willing
to pay for an option whereas the “perceived cost” is what the company sees as a cost.
For the grant of options in a fast growth company, the perceived costs might be lower
than the economic costs because there is no accounting charge and no outlay of cash.361
Finally, the close monitoring that is founded in agency theory could also reduce expen-
ditures for the managers’ compensation. This is because control through monitoring
could to some extent replace incentives through variable compensation. 362
Consequently, good corporate governance in this context means that the managerial
compensation on one hand reduces the risk of opportunistic behaviour by means of
variable elements that are linked to the company’s mid- and long-term development
and on the other hand should have a relatively low level of cash payments.
357
Berle/Means (1932); Aggarwal/Samwick (1999), p. 66; Lippert/Moore (1995), pp. 55.
358
McGuire (2000), p. 34.
359
Markman et al. (2001), pp. 280ff.; for a theoretical analysis of managers’ variable compensation refer to
Cyert et al. (2002), pp. 453ff.; Bloom/Milkovich (1995), pp. 1ff.
360
Hoffmann, G. (2003), p. 158ff.; for a detailed review on the effects of managerial ownership refer to
3.1.2.2.
361
Murphy (2003), p. 143; Chua/Woodward (1993), pp.52ff.; Beatty/Zajac (1994), pp. 315ff.; c.f. Anderson
et al. (2000), pp. 530ff.
362
C.f. Core et al. (1999), pp. 372ff.
82
It could be expected that venture capitalists realise this lever and influence the
managers’ compensation accordingly. As blockholders, they should be able to
influence the compensation structure either in the contracting phase before the invest-
ment is done or during the investment through the board363 or shareholder meetings.
Empirically, it is shown that venture capitalists as outsiders might align executive

compensation to foster long-term value creation of growth companies.364 Findings
suggest that, particularly in high-technology growth companies, stock options play an
important role in managers’ and board members’ compensation.365 A broader study
that looks at high growth companies in general — which are often financed by venture
capitalists — supports the strong use of stock options. MURPHY analysed the use of
options in so-called new economy firms and found that they are a reason why many of
the companies posted positive instead of negative earnings. If, in 1999, all analysed
American new economy firms had used only cash for the compensation, 45% of the
companies would have had to post negative pre-tax income whereas in reality, with the
use of stock options, only 23% did.366 This underlines how crucial the managers’ com-
pensation is for high-growth companies with few financial resources.
Apart from that, venture capitalists might also reduce expenditures for the managers’
compensation, but the empirical findings here are mixed. BAKER/GOMPERS show
that monitoring replaces financial incentives. The performance elasticity of the
managers’ compensation is higher in venture capital-backed companies than in non-
venture-capital-backed-companies. This is associated with a lower ownership share of
the managers.367 This higher sensitivity indicates that managers’ compensation is
closely monitored and adjusted to their performance so that the expenditure of the
compensation is reduced in the case of weak performance. However, this is in contrast
to the results of ENGEL ET AL. who found that companies with venture capital
backing have lower overall use of incentive pay. This means that the annual CEO
compensation grants are less associated with firm performance than in companies
without venture capitalists. This indicates that the compensation, and in particular the
variable compensation, could not be reduced by the venture capitalists’ close
363
For more information on the relationship between board control and managers’ compensation, refer to
Boyd (1994), pp. 335 ff.
364
Zahra et al. (2000), p. 955.
365
366
Murphy (2003), p. 145.
367
83
monitoring. Their analysis shows that compensation grants of firms with little or no
venture capital influence display a significantly stronger association with accounting
and stock performance measures than those of firms with more intense monitoring by
venture capitalists.368 This is supported by another empirical study by HE/CONYON
indicating that venture capitalists’ presence is related to lower incentives for the
managers.369 There are two possible ways of explaining this relationship: First, costly
performance pay could be reduced by close monitoring by venture capitalists.370 That
means the overall managers’ compensation would be reduced. Second, there could be
a problem with measuring the pay–performance relationship. In growth companies,
current measures might not be appropriate to assess the performance so that the
managers’ compensation must also not be associated to current performance but to
other information that might only be accessible to well-informed venture capitalists.371
Venture capitalists might, for example, relate the variable compensation to milestones
set in the portfolio companies’ business plans that might be not directly related to
accounting measures.372
According to agency theoretic explanations and the preponderant results of the

empirical studies, it could be expected that venture capitalists know the importance of
appropriate compensation and balance the use of incentives and expenditures
accordingly, which is considered an element of good corporate governance.
H2.3: The venture capitalists' influence has a positive impact on the compensation of
managers.
Consequently, it could be expected that venture capitalists’ influence on the managers’

compensation leads to a stronger use of variable compensation elements.
H2.3.1: The stronger the venture capitalists’ influence, the higher is the proportion of
the variable compensation.
The variable instruments used should also be influenced by venture capitalist to be

linked to mid- and long-term goals.
368
Engel et al. (2001), pp. 502ff.
369
He/Conyon (2004), p. 56.
370
Engel et al. (2001), p. 509; c.f. for the substitutability of corporate governance refer to Rediker/Seth
(1995), pp. 85ff.
371
Engel et al. (2001), p. 511 and 514.
372
Engel et al. (2001), p. 514.
84
H2.3.2: The stronger the venture capitalists' influence, the more likely is the use of
variable compensation parts linked to mid- and long-term goals.
Finally, close monitoring by venture capitalists and the scarce resources of the port-
folio company should guide the venture capitalist to reduce overall cash compensation.
H3.3.3: The stronger the venture capitalists’ influence, the lower is the cash
compensation of the managers.
4.2.2 Board
The board constitutes a core corporate governance element for both underlying
theories, the agency theory and the dynamic resourced-based view: On one hand, it is a
key monitoring instrument that should reduce the opportunistic behaviour of the
managers. On the other hand, the board also improves the management of a company
because it can contribute to the effectiveness of the decision making by improving the
capabilities of the company. Venture capitalists are expected to influence both the
composition and the work of boards.373
4.2.2.1 Composition
Three aspects of the composition of boards are considered to be particularly important:
independence, qualification and size.374 To fulfil the demanding monitoring and advice
functions, members of the board should be independent and qualified. In the case of
growth companies, the role as an adviser for the managers is just as important as the
role as a controller because they are not only associated with high agency and business
risk but also with a lack of competence because of their scarce resources.375 According
to the foundations, it is expected that venture capitalists recognise the importance of
the composition of the board and therefore exert influence.
H2.4: The venture capitalists' influence has a positive impact on the composition of the
board.
373
For a literature review on boards in small and medium-sized companies, refer to Huse (2000) or for a
more general review to Johnson et al. (1996); Dalton et al. (1998), pp. 269ff.; for an analysis of factors for
the evaluation of boards, refer to Van den Berghe/Levrau (2004), pp. 461ff.
374
Zahra/Pearce (1989), pp. 306ff. refers to composition (independence), characteristics (qualifications) and
structure (size, committees); Bassen (2002b), pp. 157ff.
375
Grundei/Talaulicar (2003), p. 194.
85
First, the appropriateness of independent boards is discussed. In this context, inde-
pendence means that the members of the board are outsiders that “are not members of
the top management team, their associates or families; are not employees of the firms
or its subsidiaries; and are not members of the immediate past top management
group”.376 Whereas, according to agency theory, independence of boards is of great
importance, there are also reasons why insiders on boards might be more valuable than
outsiders.377
Generally, board independence increases, according to agency theory, the ability of

boards to exercise control over managers and thereby positively affects a firm’s perfor-
mance.378 A high proportion of insiders may decrease a board’s ability to indepen-
dently carry out its role because insiders may feel constrained from questioning CEO
directives. Board independence enhances the ability of directors to exercise control
and thereby to protect shareholders’ interest.379 Furthermore, insiders on boards might
be reluctant to pursue long-term goals given the high risk associated with growth
companies.380 In contrast to this, outsiders might be more effective in pursuing long-
term value creation by vigorously monitoring executives and ensuring strategic
changes when agency conflicts are suspected.381 Similarly, insiders might be reluctant
to propose actions that could conflict with the CEO’s plans.382 Additionally, a parti-
cular problem might arise from CEO duality, which means that the CEO is also
chairman of the board. This can reduce the board’s influence by facilitating the CEO’s
control.383
FAMA/JENSEN explain the higher appropriateness of outside team members by

arguing that they tend to be more effective monitors of the managers because they are
generally key decision makers at other organisations and are therefore concerned with
their reputation in the managerial labour market.384
Consequently, a board that includes a great number of independent members is,

according to agency theory, considered to be a part of good corporate governance.
376
Zahra/Pearce (1989), pp. 306ff.
377
Zahra/Pearce (1989), pp. 215ff.; Kiel/Nicholson (2005), pp. 623.
378
Baysinger/Hoskisson (1990), pp. 75ff.
379
Sapienza et al.(2000), p. 333.
380
Zahra et al. (2000), p. 954; Wright et al. (1996), pp. 442ff.
381
Zahra et al. (2000), pp. 954ff.; Kroll et al. (1997), pp. 441ff.; Johnson et al (1993), p. 36.
382
Johnson et al. (1993), p. 36.
383
Finkelstei/D’Aveni (1994), pp. 1101ff.
384
Huson et al. (2001), p. 2267; Fama/Jensen (1983); Kaplan/Reishus (1990), p. 409.
86
Venture capitalists, as blockholders, should have the ability to work towards an
independent board because they can appoint own representatives to the board and have
a say on the structure of the board in the contracting phase.385
Generally, venture capitalists might increase the independence of boards in three ways:
by adding their own representatives to boards, by their influence on the selection of
outside board members and in a more indirect way by reducing the power of the
founders. Empirical studies support that venture capitalists act in accordance with the
theory as they try to foster the independence of the boards. They generally expect
members to be active and critical. They try to prevent managers from bringing friends
or relatives onto the boards.386 Their own representatives do not enjoy private benefits
of control and have strong motivation to exert monitoring.387 The analysis of
BAKER/GOMPERS shows that for the USA, with its one-tier system, that boards in
venture capital-backed companies have fewer inside and instrumental directors —
such as representatives of banks, lawyers, accountants and consultants — and more
independent outside directors.388 They show that venture capital managers replace
inside and instrumental directors in the boards.389 The study by ROSENSTEIN ET AL.
indicates that in the USA, portfolio companies have relatively great shares in boards,
particularly the most experienced and successful investors. In more than half of all
portfolio companies, they held the majority of seats.390 This refers to the first way
venture capitalists increase boards’ independence.
The empirical findings of GABRIELSSON/HUSE refer to the second possibility. They

show that the influence of venture capitalists results in more independent boards. The
ratio of outsiders on the board is higher and CEO duality is less common, which
decreases the power of insiders on the board.391 This is also backed by the analysis of
FILATOTCHEV ET AL. who provide evidence that venture capital-backed companies
that go public — and in this case in particular companies with several venture
385
Rosenstein et al, (1993), p. 104; Markman et al. (2001), pp. 281ff.
386
387
He/Conyon (2004), p. 50.
388
Baker/Gompers (2003), p. 581ff.
389
390
Rosenstein et al. (1990), pp. 240ff.
391
Garbielsson/Huse (2001), pp.134ff.
87
capitalists in a syndicate — have more independent boards than those without an
investment from a venture capitalist.392
An indirect way in which venture capitalists impact the structure of the board is by
reducing the power of the founders who might have an interest in placing family
members, friends or acquaintances on boards. DAILY/DALTON prove empirically
that boards in companies where the CEO is not the founder — and this is more likely
in the case of venture capital-backed companies as has been shown before — have a
significantly higher proportion of outsiders, which indicates a higher independence.393
BOURESLI ET AL. found in their empirical analysis that the percentage of insiders is
significantly smaller in venture capital-backed companies than in non-venture-capital-
backed companies, both before and after an IPO.394
In the case of small firms, which are typical for venture capital-backed companies,
strengthening independence might be of particular importance. This is because small
firms typically have small boards made up of the owner manager and family members,
sometimes augmented with bankers, attorneys, or friends. The resulting limited influ-
ence of outsiders gives the managers of the companies great influence.395
Empirical evidence for the value effects of independent boards comes, for example,396
from HUSON ET AL. who show a positive correlation between the share of
independent board members and forced manager turnover.397 This indicates that inde-
pendence strengthens the monitoring function of boards. Moreover, it is shown that
CEO-duality can reduce board influence by facilitating the CEO’s control of both the
agenda and the debate in board meetings.398 JUDGE/ZEITHAML also found a relation
between board independence and performance. Their analysis indicates that there is a
negative relation between insiders on boards and financial performance.399 Further
empirical support for the particular case of growth companies comes from DAILY/
DALTON who indicate a significant positive relationship between the number and
proportion of outsiders on the boards of growth companies and firm performance mea-
392
Filototchev et al. (2005), p. 20.
393
Dailey/Dalton (1992), p. 380.
394
Bourseli et al. (2004), pp. 77ff.
395
Rosenstein (1988), p. 161; in the German two-board system, the owner-manager is not member of the
supervisory board but as an owner he/she can determine representatives.
396
For further empirical support refer to Rechner/Dalton (1990), pp. 155ff.; Boyd (1995), pp. 301ff.
397
Huson et al. (2001), pp. 2289ff.
398
Sapienza et al. (2000), p. 334; Finkelstein/D’Aveni (1994), pp. 1093ff.
399
Judge/Zeitlhaml (1992), p. 782.
88
sured by return on equity and return on assets. They explain this as stronger control of
the managers.400 ROSENSTEIN/WYATT use a different approach to support this: they
show positive share-price effects of appointments of outside board members.401
In contrast to this, some scholars dispute the purported positive effects of outsiders on
boards. They suggest that these board members lack the expertise and requisite time to
effectively exercise their role.402 It is argued, for example, that outside members of
boards do not have current or past professional or personal associations with the firm,
which are necessary to evaluate the firm's situation.403
Following agency theory and the greatest part of the empirical studies,404 it can be
expected that the influence of venture capitalists leads to more independent boards,
which is considered to have positive effects on the value of growth companies.
H2.4.1: The stronger the venture capitalists’ influence, the greater is the proportion of
independent members in the board.
Given the different arguments regarding the independence of boards,

ZAHRA/PEARCE suggest that the effectiveness of boards is not a question of insiders
versus outsiders but is rather a question of the characteristics of the members, in
particular their qualification.405 Better-qualified board members can better assess and
assist firms and might therefore lead to higher performance for the firm.406 A board
could be ineffective because its members are unable to evaluate the information given
to them, to recognise the problems of a firm or to punish the managers. This problem
is particularly relevant in growth companies, where good information is often missing
and performance is difficult to measure.407 According to the dynamic resource-based
view, the qualification of board members should have a great influence on the effec-
tiveness of the board. The more qualified the members are, the better the decision
making process should be. Portfolio companies have typically small management
teams with limited experience, which requires involving people who can make up for
400
Daily/Dalton (1992), pp. 380ff.
401
Rosenstein/Wyatt (1990), pp. 184ff.
402
Zahra/Pearce (1989), p. 315; Westphal (1999), pp. 7ff.
403
Zahra et al. (2000), p. 954; Johnson et al. (1993), pp. 35ff.
404
Zahra/Pearce (1989), p. 316.
405
Zahra/Pearce, p. 316; for an overview of important qualifications of board members, refer to
Nicholson/Kiel (2004), p. 450.
406
Dimov/Shepherd (2005), pp. 2ff.
407
Jensen (1986), pp. 323ff.; Audretsch/Lehman (2002), p. 16.
89
their deficits. The board members could contribute to this if they complement and
strengthen the knowledge, experiences and capabilities of the management team.
Consequently, having board members with experiences in different areas to comple-
ment the managers is considered good corporate governance because it contributes to
informed decision making.408 Venture capitalists should have gained specific
knowledge and experience about the business development of growth companies from
their numerous investments, so they should be particularly capable to serve in
boards.409 They are likely to have a comparative advantage over other equity investors
in monitoring managers of growth companies. Furthermore, they might know what
important functions are missing in the management team of a company and might have
access to people who could fill this gap by being a member of the company’s board.410
AUDRETSCH/LEHMANN provide empirical evidence that the qualification of board

members is highly important for the performance of growth companies. They show
with a sample from the German Neuer Markt that the level of human capital in the
supervisory board dwarfs the role of managerial ownership in influencing firm perfor-
mance measured by the survival of firms.411 This supports that high qualification of
board members strengthens the corporate governance of a company and enhances the
performance of a company.
ROSENSTEIN ET AL. empirically support the particular abilities of venture

capitalists as board members. According to their study, the involvement of venture
capitalists’ representatives on boards is considered by the CEOs of portfolio
companies to be more valuable than that of other outside board members, particularly
if the venture capitalists belong to the “top 20 investors”.412 Venture capitalists also
focus on the overall qualification of the board. They expect boards as a whole to be
diversified so that roles are diversified and complement the management team.413 In
order to achieve the required independence and qualification of the board, venture
capitalists help find suitable board members within their networks.414 They pay
408
Hillman et al. (2000), pp. 239ff.; social ties of board members are a further important resource, for more
information refer to Carpenter/Westphal (2001), pp. 639ff.
409
Berg/Gottschalg (2003), p. 30.
410
Hellmann/Puri (2002), pp. 176ff.
411
Audretsch/Lehmann (2002), pp. 25ff.
412
Rosenstein et al. (1990), p. 244.
413
414
90
attention to the diversification of the roles of the board members so that they
complement the managers.415
According to the theoretical explanation and the empirical findings, it can be assumed
that the venture capitalists’ influence leads to better-qualified boards in regard to its
members’ experiences.
H2.4.2: The stronger the venture capitalists’ influence, the stronger are the experiences
of the board.
The third aspect of the structure of the board is its size. Beyond a small number, board
size is likely to have a negative relationship with board involvement and effectiveness.
As groups get larger, interaction between group members diminishes. Thus when
boards get too large effective debate and discussion may be limited and the level of
board involvement may decrease.416 DALTON ET AL. found that this relation between
board size and firm performance is stronger for small companies than for larger
ones.417
Venture capitalists’ might increase the size of their boards by introducing additional
members. It is shown that boards in venture capital-backed companies are bigger than
in non-venture-capital-backed companies.418 But such an increase must probably be
seen in relation to the absolute number because a negative effect of board size on its
effectiveness should only be expected beyond a certain size. VAN DEN BERGHE/
LEVRAU suggest six members to be appropriate number of board members for ven-
ture capital-backed companies.419 Empirical studies show that this corresponds to the
majority of companies despite the expansion of the boards at the time of the invest-
ment by a venture capitalist.420 Consequently, the size aspect can be considered to be of
no particular concern in venture capital-backed companies. Venture capitalists might
recognise the advantages of small boards and might therefore not increase their size
too much.
415
416
March/Simon (1958); Harrison (1987), pp. 109ff; Sapienza et al. (2000), p.333; Pfeffer (1972), pp. 218ff.;
Yermack (1996), pp. 189ff.; Dalton et al. (1999), pp. 674ff.
417
Dalton et al (1999), pp. 674ff.; Daily et al (2002), p. 388.
418
Garbielsson/Huse /2001), pp.134ff.
419
420
Rosenstein (1993), p. 104; the mean size of venture capital–backed boards in the USA was 5,62,
compared to 4,81 for non-venture-capital-backed companies.
91
4.2.2.2 Work
The analysis of the boards’ work refers to two aspects, the formal attributes and the
level of involvement. On one hand, the effectiveness of the board’s work is determined
by attributes such as frequency, preparation and formality of board meetings. On the
other hand, the areas that are dealt with and the assigned role of the board are also
relevant when the quality of the board’s work is assessed, particularly involvement in
strategic decision making.421
It is expected that the venture capitalists recognise the importance of the boards' work
and influence it accordingly.
H2.5: The venture capitalists' influence has a positive impact on the work of the board.
The effectiveness of board meetings is essential to fulfil the demanding role of boards.
Formality can add to the effectiveness of board meetings. The close monitoring that
agency theory considers necessary could be realised through frequent and well-
prepared board meetings. Board meetings must take place regularly and promptly so
the members can fulfil the monitoring role efficiently. Moreover, the decisions by the
board should be based on comprehensive information. This might require having the
information before the board meeting in order to prepare.422 Consequently, good cor-
porate governance in this context requires frequent board meetings that are well
prepared. Venture capitalists, as blockholders, should be able to influence the for-
mality of board meetings either at the time of contracting or after the decision through
their membership on the board or their decision rights in the shareholder meetings.
ANDERSSON/GUNNARSSON undertook an analysis in Sweden and found that

venture capitalists changed the work of the board fundamentally. In one of the two
researched cases, there were no formal board meetings before the venture capitalist
invested in the company. The founders of the company discussed issues as they
emerged. But after the investment of a venture capitalist, this changed as the board
then met regularly to discuss operating and strategic issues.423
421
Ingley/Van der Walt (2005), pp. 632ff.
422
Zahra/Pearce (1989), p. 310.
423
92
Consequently, it can be expected that the venture capitalists’ influence increases the
formality of board meetings. Venture capitalists’ influence should lead to more
frequent and better-prepared board meetings.
H2.5.1: The stronger the venture capitalists’ influence, the more frequently board
meetings take place.
H2.5.2: The stronger the venture capitalists’ influence, the better prepared board
meetings are.
Apart from that, the reach of boards is important. The involvement of boards in
strategic decision making is seen as positive by both agency theory and the dynamic
resource-based view. Whereas agency theory stresses its importance in the context of
effective monitoring, the dynamic resource-based view focuses on the improvement of
managerial resources that might lead to better decisions.424
Effective monitoring, which is required by agency theory, is only possible if the board
is involved in all important management decisions. Therefore, the board should control
the managers in all relevant areas.425
According to the dynamic resource-based view, corporate governance could lead to

strategic advantages by improving the decision making processes in a company. In
growth companies, which often have scarce human resources and limited quali-
fications in the management team, the involvement of qualified board members in the
decision making process could make up for the limitations. Hence, the board should be
actively involved in the strategic decision making process and advise the managers in
all relevant areas.426
Consequently, good corporate governance is assumed to be in place if the board is

involved in strategic decision making in all relevant areas of the company. Venture
capitalists should understand the necessity for the board to be involved in the decision
making process from their investment experience and should also be able to enforce
this.
424
Hung (1998), pp. 104ff.
425
426
Zahra/Pearce (1989), Hung (1998), pp. 104ff.
93
Several empirical analyses look at these aspects. Generally, the proportion of outside
board members has been found to be positively related to board involvement in strate-
gic decision making.427 And as was shown before, venture capitalists increase the
number of outsiders on boards. JOHNSON ET AL. proved empirically that the hypo-
thesis holds that board involvement grows with outsider members.428 The findings of
ROSENSTEIN ET AL. show the special role of venture capitalists. They found that
there is no indication that boards in small firms are generally involved in the strategy
formulation of the firm, even if they include outsiders.429 In contrast to this, boards in
venture capital-backed companies are highly involved in strategic decision making.
This constructive role of the venture capital-backed board is often appreciated by the
managers.430 Consequently, the venture capitalists’ presence, which might generally be
linked to a higher proportion of outside board members, should lead to a stronger
board involvement in strategic decision making.
Qualitative analyses that might be particularly appropriate to evaluate board involve-

ment support the positive effects of venture capitalists’ influence. ANDERSSON/
GUNNARSON also found that the venture capitalists’ board members improve the
managerial resources of portfolio companies by bringing in managerial competence.
This improvement of the resources was achieved by more managerial experience, the
new role of the board as a sounding board and its activity to set strategic directions.431
This is supported by the analysis by GUSTAFSSON that indicates that the represen-
tatives of venture capitalists on portfolio companies’ boards are involved in both moni-
toring and support activities. This is achieved by discussing issues in detail during
board meetings and by a close working relationship between the venture capitalists’
board members and the managers. All the CEOs of the portfolio companies inter-
viewed stated positive effects on their business after venture capitalists had been
involved.432 Another qualitative analysis was done by DEAKINS ET AL. for the
United Kingdom. It reveals that venture capitalists change the work of boards. Where-
as there is only a small improvement in the boards’ involvement in strategic planning,
there are greater effects on the outcome: 73% of the CEOs of venture capital-backed
427
Judge/Zeithaml (1992), p. 782; additionally, it was found that non-executive directors are more involved
in strategic decision making in non-listed companies than in listed companies; for more information refer
to Long et al. (2005), pp. 667ff.
428
Johnson et al. (1993), p. 43.
429
Rosenstein (1988), pp. 161ff.
430
Rosenstein (1988), pp. 165ff.
431
432
Gustafsson (1998) according to Gabrielsson/Huse (2002), p. 138.
94
companies stated that strategic planning was improved by the board involvement,
whereas this was the case in only 50% of non-venture-capital-backed companies.433
FRIED ET AL. found comparable results in a quantitative analysis for the USA.
Boards in venture capital-backed companies had a higher level of strategic involve-
ment as well as a stronger involvement in the evaluation of the companies’ strategy
than boards in non-venture-capital-backed companies. They consider board members
as consultants for the top management team within as well as between board mee-
tings.434 Additionally, they also indicate a positive influence on the companies’ perfor-
mance. Using performance in relation to the average performance of companies in an
industry as a measure, they found that the sample with the venture capital-backed
companies performs better than its counterpart.435 This is supported by the findings of
JUDGE/ZEITHAML that influence by the board in strategic decision making
correlates to positive financial performance as measured by accounting indicators.436
FREDRIKSEN/KLOFSTEN analyse the performance effect of different types of

boards in venture capital-backed companies. Among the three board types in place in
companies with rather formal relationships between venture capitalists and the
managers of the portfolio companies — in contrast to those companies with more
informal relationships characterised by trust and openness — the ones with the highest
activity, involvement in decision making and integrity of the members are associated
with the highest economic performance.437
Given these theoretical and empirical findings, it can be expected that venture
capitalists’ influence increases the level of involvement of boards. This should be the
case in particular for strategic decision making.
H2.5.3: The stronger the venture capitalists’ influence, the more involved is the board
in strategic decision making.
433
Deakin et al. (2000), p. 121.
434
Fried et al. (1998), p. 498.
435
Fried et al. (1998), p. 499.
436
Judge/Zeitlhaml (1992), pp. 782ff.
437
Fredriksen/Klofsten (1999), p. 6.
95
4.2.3 Reporting Discipline
Reporting information provides the basis for effective control of companies and is
therefore essential for good corporate governance.438 Agency problems can arise
because of asymmetrical information between the managers and the shareholders of a
company. To prevent these problems, agency theory proposes closely monitoring the
development of the company and the decisions of the managers. But effective moni-
toring requires comprehensive information as a basis. Hence, the shareholders and the
board members have to frequently and promptly receive relevant information in order
to be able to intervene if needed.439 Consequently, the frequent and prompt supply of
relevant and accurate information to shareholders and board members is considered
good corporate governance. The effectiveness and efficiency of the reporting disci-
pline depends on one hand on formal attributes such as the frequency, timeliness and
the content as well as on the accuracy of the reporting on the other hand.
The following hypothesis is based on the foundations laid before:
H2.6: The venture capitalists' influence has a positive impact on reporting discipline.
The formal attributes are a basic requirement to keep board members, shareholders
and other stakeholders informed about the company’s development. The reporting
should be frequent and without a big delay so that the different parties can react
promptly to the information provided. Furthermore, the information provided should
be comprehensive; all important developments should be reported. Given their invest-
ment and business development experience, venture capitalists should realise the
importance of reporting. As blockholders, they should have the rights to enforce
effective reporting in their portfolio companies by means of adequate contractual pro-
visions as well as during the investment phase.440
Empirical analyses show that venture capitalists use information from the financial
statements at the time a portfolio company is selected441 and also during the investment
phase.442 They have specific requirements of their portfolio companies’ reporting: They
generally demand a monthly report by their portfolio companies informing them about
438
Bushman/Smith (2001), p. 238; Sloan (2001), pp. 335ff.
439
Bushman/Smith (2001), p. 238; Falconer et al. (1995), pp. 187ff.
440
Falconer et al. (1995).
441
Macmillan et al. (1987), pp. 125ff.; Wright/Robbie (1998), pp. 533ff.
442
Falconer et al. (1995); Huber/Böhler (2003), pp. 1002ff.
96
the current business development and the achievement of the quantitative and quali-
tative targets.443 The findings of FALCONER ET AL. provide evidence that the repor-
ting information provided to venture capitalists is more comprehensive and more
frequent than the information in the general shareholder reports. According to their
study, the influence of venture capitalists increased the frequency of reporting consi-
derably from a statutory annual or bi-annual report to monthly reports. The reports
were additionally more detailed and often also included qualitative information on the
performance of the company as well as information specifically required by the
venture capitalists. In some cases, the reports had to be provided within a very strict
time limit.444 BEUSELINCK ET AL. found that venture capital-backed companies
report losses more promptly than non-venture-capital-backed companies, which also
indicates the venture capitalists’ influence.445
Accordingly, it can be assumed that venture capitalists use their influence to improve
the quality of this corporate governance element.
H2.6.1: The stronger the venture capitalists’ influence, the more frequent is the
portfolio company’s reporting.
H2.6.2: The stronger the venture capitalists’ influence, the more timely is the portfolio
company’s reporting.
H2.6.3: The stronger the venture capitalists’ influence, the more comprehensive is the
The second important aspect of reporting is its accuracy. If stakeholders base

decisions on the information provided, the information must be right. But accounting
information can be used at specific dates to mislead potential investors or to influence
contract terms.446 Their close monitoring and control rights should give venture capi-
talists the ability to recognise problems with the accuracy of the reporting and also the
power to enforce changes.447
There are two empirical studies that support the idea that venture capitalists’ influence
results in improved reporting discipline. First, BEUSELINCK carried out an analysis
443
Ruppen (2001), p. 161.
444
Falconer et al. (1995), pp. 190ff.
445
Beuselinck et al. (2004), p. 24.
446
Refer to Healy/Wahlen (1999) for a literature overview.
97
in Belgium. It indicates that venture capitalists influence the corporate governance of
their portfolio companies and thereby reduce their discretional accruals. This is parti-
cularly relevant as the same study also found that companies that receive venture
capital have higher discretionary accruals in their results than companies that do not.448
HOCHBERG found similar results in her American research that looked at companies
at the time of IPO. She found that venture capital-backed firms have lower earnings
management, measured by their discretionary accruals, than similar companies not
backed by a venture capitalist.449
These findings lead to the next hypothesis:
H2.6.4: The stronger the venture capitalists’ influence, the more accurate is the
The following figure illustrates the expected relationship between the venture
capitalists’ influence and the impact on corporate governance in an overview.
Impact on
Corporate
Governance
Assessment/Selec-
tion of managers
Venture
Capitalist's Bonding of
Influence managers
H2
Compensation of
Intensity
managers
Composition of
CG-Elements
board
Work of board
Reporting discipline
Figure 13: Relationship between venture capitalists' influence and corporate governance
447
Falconer et al. (1995), p. 193.
448
Beuselinck et al. (2004), p. 21.
449
Hochberg (2002), pp. 7ff.
98
4.3 Abilities of Venture Capitalists To Influence Corporate
Governance
According to earlier findings, venture capitalists’ impact on the corporate governance
of portfolio companies is determined not only by their reasons for the influence but
also by their abilities. Following the literature review, the abilities can be distinguished
in the control rights and the characteristics of the venture capitalists, i.e., the charac-
teristics of the venture-capital firm on one hand and of the investment manager on the
other hand. This section details the relationship between venture capitalists’ abilities
and their impact on corporate governance.450
4.3.1 Control Rights

The venture capitalists’ control rights significantly determine their impact on the
corporate governance of portfolio companies. If the venture capitalists are willing to
influence the corporate governance, they must also have the rights to enforce their
points. The control rights enable them to effectively influence portfolio companies.
To begin with, the general hypothesis related to this section is:
H3: The abilities of venture capitalists have an impact on the corporate governance of
portfolio companies.
Generally, the level of ownership of a venture capitalist determines the importance of

the investor for the portfolio company as well as the importance of that investment for
the venture capitalist. But in the case of venture capital, ownership must be diffe-
rentiated from decision rights because they can differ. Particularly in the influence of
venture capitalists on portfolio companies, the decision rights might be more important
than the ownership rights. This is because the venture capitalists’ decision rights might
be greater than their ownership rights. This can be reached by introducing unvested
stock options, non-voting stock or explicit covenants that authorise the investor to
exercise votes depending on specific targets.451 These instruments give venture capi-
talists control rights but grant the managers sufficient ownership in the company to
give them incentives to develop the company to increase the value of their shares.
450
It should be noted that the impact depends not only on the venture capitalists and their rights but also on
characteristics of the management teams of the portfolio companies; for more information refer to Barney
et al. (1996b).
451
99
Consequently, the control rights of venture capitalists are determined by the levels of
ownership and the decision rights. The decision rights include seats in the board as
well as veto rights.
The ownership level of the venture capitalists strongly determines the ownership level
— and thereby the demand for decision rights — of the managers of the company,
who are generally inside investors. BOURSELI ET AL. show empirically that venture
capital backing reduces managers’ ownership significantly.452
In regard to decision rights, the board membership is an important instrument to

influence corporate governance that is normally granted only to investors that possess
a certain share in a company. According to the empirical analysis of RUPPEN, venture
capitalists demand a seat with an ownership share of 17,8%.453 This supports the
finding by BAKER/GOMPERS that a threshold ownership level is more important for
venture capitalists than high ownership per se.454
According to the empirical analysis for the USA undertaken by

KAPLAN/STRÖMBERG, venture capitalists have the majority of board seats in 25%
of the analysed cases, whereas the founders dominate the one-tier-system boards in
only 14% of the cases. Whereas after the first financing round, control by venture
capitalists is less common, it tends to have the majority of votes thereafter. However,
in most cases the venture capitalists do not own the majority of the portfolio com-
pany’s shares.455 This indicates differences between ownership and decision rights.
However, a German analysis by RUPPEN comes to partly different results. In
Germany, the venture capitalists dominate the supervisory board only rarely. In about
half of all cases they have a voting power of less than 25%, which points to lower
control among German venture capitalists than among their US counterparts.456
Based on this, it can be expected that the control rights determined by ownership and
decision rights are positively related to the venture capitalists’ impact on the corporate
governance of portfolio companies.
452
Bouresli et al. (2004), p. 80.
453
454
Baker/Gompers (2003), pp. 576ff.
455
Kaplan/Strömberg (2003), pp. 289ff.
456
100
H3.1: The control rights of venture capitalists have a positive impact on the corporate
H3.1.1: The stronger the venture capitalists' control right rights, — in terms of
ownership rights and board seats — the stronger is their influence on the corporate
It can be expected that the control rights predominantly determine the corporate
governance elements related to the monitoring and bonding functions of corporate
governance. This is because these functions are mainly based on decisions made
during the contracting phase or in board or shareholder meetings where the control
rights are decisive. Venture capitalists can use their control rights, for example, to
accomplish their goals in the contracting phase and to introduce requirements for the
managers. This can be done by means of the shareholder agreement or by changing the
articles of association. Venture capitalists might ask for a number of board seats, for
regular reporting or for changes in the board composition. Such negotiations are not
limited to the first investment by a venture capitalist but can also be done at later
financing rounds. Thus, venture capitalists can enforce their requirements when they
have gained further control rights. Additionally, they can use their board seats to exert
influence on corporate governance. The board has far-reaching rights related to corpo-
rate governance that include, for example, the selection, evaluation and compensation
of the managers as well as the reporting of the company. Consequently, it can be
expected that venture capitalists’ control rights should determine their impact on the
elements related to the monitoring and bonding functions of corporate governance.
H3.1.2: The stronger the venture capitalists' control rights, the greater is the impact of
their influence on the elements related to the monitoring function of corporate
governance.
H3.1.3: The stronger the venture capitalists' control rights, the greater is the impact of
their influence on the elements related to the bonding function of corporate
governance.
4.3.2 Characteristics of Venture Capitalists

Characteristics of venture capitalists might have an impact on their influence on the
corporate governance of portfolio companies. This might be related either to
characteristics of the venture capital firms or to those of the specific investment
101
manager. This relationship corresponds to the dynamic resource-based view that traces
differences in outcomes back to different resource endowments. Hence, different
venture capitalists might have different resources in regard to experience, capabilities
and time that might influence the effects of their influence on the corporate gover-
nance of portfolio companies.
4.3.2.1 Characteristics of Venture Capital Firms

Venture capital firms differ in various characteristics that might lead to different goals
and different patterns of influence on portfolio companies’ corporate governance. In
particular, four characteristics of venture capital firms are considered to determine
their involvement. It is expected that these characteristics influence the impact of the
venture capitalists.
H3.2: The characteristics of venture capital firms have a positive impact on the
First, the type of venture capital firm determines its strategy and operations.
Following the approach of TYKVOVA, four types of venture capital investors are
distinguished according to their own governance structure: independent, bank
dependent, corporate and governmental. The results indicate significant differences in
their investment behaviour, in the level of syndication, preferred stages, equity
positions, time to IPO and retained equity positions after IPO.457 The differing
investment patterns predict differences in the influence of the venture capital firm
types on the corporate governance of their portfolio companies.458 This is supported by
BEUSELINCK ET AL. who compare the influence of independent and governmental
venture capitalists in regard to their influence on the reporting discipline of their port-
folio companies. They find support for the hypothesis that independent venture capital
firms have stronger effects on reporting discipline because they reduce earnings
management more strongly than public investors.459 They explain this difference as
result of specific characteristics of the investors, in particular the capabilities, goals
and investment patterns. Investment managers of governmental venture capital firms
are often civil servants who lack experience as well as incentives to effectively influ-
457
Tykvova (2004), pp. 7ff.
458
For differences in the involvement on corporate governance by informal and formal venture capitalists
that are not examined here, refer to Whincop (2000), pp. 13ff.; Von Osnabrugge (1999); Sapienza et al.
(1996), p. 462.
459
Beuselinck et al. (2004), pp. 10 and 24.
102
ence the corporate governance of the portfolio companies.460 They are under less
pressure to quickly generate financial returns because they might have different goals
and they do not have to raise money from the capital markets. Public venture capital
firms might have social rather than financial goals.461
Corporate venture capital firms’ primary motivation is generally the realization of

strategic goals. To achieve this, they foster interaction between portfolio companies
and the big corporation. Often, the investment managers are former employees of the
corporation and have more knowledge in the specific industry than in the venture
capital industry.462 Hence, corporate venture capital firms are more focussed on
strategic issues and less on value generation in the portfolio companies. Additionally,
they might lack the experience required to improve corporate governance.
Bank-related venture capital firms also have strategic goals rather than value creation
in the portfolio companies. They invest selectively in comparatively small stakes to
build relationships with portfolio companies that could become customers of the
banks. According to the empirical analysis by HELLMANN ET AL., they lack the
required skills and incentives for value creation in portfolio companies.463 Therefore,
their impact on the corporate governance of portfolio companies can be expected to be
less strong than the impact of independent venture capital firms.
Consequently, the type of venture capital firms can be expected to influence its
strategy and operation and hence also its influence on the portfolio companies’
corporate governance. More precisely, it can be expected that independent venture
capitalists have a stronger focus on financial issues and value creation, which should
lead to a stronger focus on corporate governance compared with corporate, bank-
related and governmental venture capital firms.
H3.2.1: Independent venture capital firms’ influence has a greater impact on the
corporate governance of portfolio companies than that of corporate venture capitalists
and bank-related and governmental venture capitalists.
460
Leleux/Surlemont (2003), pp.82ff.; Manigart et al. (2002), p. 291 ff.;Beuselinck et al. (2004), p. 10.
461
Lerner (1999), pp. 285ff.; Beuselinck et al. (2004), p. 10.
462
Winters/Murfin (1988); Sykes/Block (1989), pp. 160ff.; Sykes (1990), Sykes (1992); Witt/Brachtendorf
(2002).
463
Hellmann/Lindsay/Puri (2004).
103
Second, investment experience might have an influence on the impact of the venture
capital firms as well. Abilities can be increased by accumulating experiences over
time. The information and skills of a venture capital firm should increase with expe-
rience in their industry.464 Venture capital firms might learn from earlier investments
and use that experience to improve future behaviour regarding influence on portfolio
companies so that the number of a venture capitalist’s investments should have an
impact on the effects of its influence.
H3.2.2: The more investment experience a venture capital firm has, the greater are the
effects of its influence on the corporate governance of portfolio companies.
Apart from general investment experience, international experience might also play a
role. International activity can increase a venture capital firm’s capabilities in influ-
encing portfolio companies.465 This might be particularly important in regard to
corporate governance because corporate governance systems differ greatly by
country466 so that investing on an international level might provide venture capital
firms with insights in best practices from other countries, which might positively
impact the effects of the venture capitalists’ influence.
H3.2.3: The greater the international experience of the venture capital firms, the
greater are the effects of their influence on the corporate governance of portfolio
companies.
Another characteristic is the reputation of venture capital firms. Venture capital firms
with great reputation might be, on one hand, more attractive for portfolio companies
because they might send a positive signal to other stakeholders. In order to get the
support of reputable venture capitalists, management might have to give their opinion
high importance.467 On the other hand, it might be that those venture capitalists possess
a greater assertiveness because their advice is considered more valuable by manage-
ment.468 BAKER/GOMPERS show empirically that venture capital firms with better
reputations have more board seats in their portfolio companies than those with worse
reputations.469 Hence, it can be expected that the reputation and experience of venture
464
465
466
Denis/McConell (2003), pp. 1 ff.
467
C.f. Hsu (2004), pp. 1805ff.
468
469
104
capital firms determine the extent of their influence on portfolio companies’ corporate
governance.
H3.2.4: The greater the reputation of a venture capital firm, the greater are the effects
of its influence on the corporate governance of portfolio companies.
4.3.2.2 Characteristics of Investment Managers

The influence of venture capitalists on portfolio companies’ corporate governance is
not only determined by the characteristics of the venture capital firms but also by those
of the investment managers. This relates, on one hand, to the experiences and
capabilities that they possess and, on the other hand, to their commitment.470
The influence of investment managers depends on their experiences and capabilities.471

According to the study by DIMOV/SHEPHERD, there is a relation between the
human capital of the investment managers and the performance of their portfolio
companies. This is because the assistance of the investment managers influences the
success of the portfolio companies.472 In the case of board members, normally only
senior people represent venture capitalists.473 Nevertheless, their experiences and
capabilities might still differ greatly. Consequently, it is expected that the charac-
teristics of investment managers have an impact on the effects of venture capitalists on
the corporate governance of portfolio companies.
H3.3: The characteristics of investment managers have a positive impact on the

Parallel to the explanations for venture capital firms, investment managers can also
increase their abilities by accumulating investment experience.474 The specific know-
ledge and understanding that investment managers acquire over time might guide them
to assess the requirements of portfolio companies and to better adjust the influence on
corporate governance. However, there might be a specific point at which further gains
in experience no longer lead to an increase in performance of the managers.475 None-
theless, it is expected that investment managers’ experience in the venture capital
470
Adner/Helfat (2003), p. 1020.
471
Dotzler (2001), pp. 6ff.
472
Dimov/Shepherd (2005), pp. 3ff.
473
Rosenstein (1993), p. 104; Gorman/Sahlman (1978), p. 234.
474
Carpenter et al. (2003), pp. 812ff.
475
Dimov/Shepherd (2005), p. 5; Shepherd et al. (2003), pp. 383ff.
105
industry has an impact on their influence on the corporate governance of portfolio
companies.
H3.3.1: The greater the investment manager’s experience in the venture capital
industry, the greater is the impact of his/her influence on the corporate governance of
Furthermore, the industry experience of investment managers might also have an

effect on his/her impact on corporate governance. The assertiveness of the propositions
by investment managers might be stronger if other shareholders highly value their
knowledge and experience. This might be the case — particularly from the perspective
of the portfolio companies’ managers476 — if investment managers bring experience in
the portfolio companies’ industries. Additionally, industry experience might also
strengthen the investment managers’ abilities to assess portfolio companies’ situations
and needs, which could have a positive impact on their influence on corporate
governance.
H3.3.2: The greater the investment managers' experience in the portfolio company’s
industry, the greater is the impact of their influence on the corporate governance of
Similarly, this might be true for the investment managers’ international experience.
The explanation for the expected relationship between international experience and
impact on corporate governance given for venture capital firms also holds for
investment managers. CARPENTER ET AL. analysed the influence of the experiences
of venture capitalists’ representatives on the portfolio companies’ boards on the
companies’ willingness to take risk. This was done in the context that investment
managers often also serve as board members in portfolio companies. Risk-averse
managers might not maximise the companies’ value because they do not realise all
risky but cashflow-positive project opportunities.477 The authors take the example of
internationalisation of firms — which might be risky but could support value maximi-
sation — and found a significant relationship between the international experience of
the venture capitalists’ board members and the internationality of portfolio
companies.478 Similarly, their international experience might have an impact on the
476
477
Jackson/Dutton (1988) describe this as a “threat bias” of managers.
478
Carpenter et al. (2003), p. 812.
106
investment managers’ influence on portfolio companies’ corporate governance, in
particular because of the great international differences in this field.479
H3.3.3: The greater the investment managers' international experience in the venture
capital industry, the greater is the impact of their influence on the corporate
Another factor that might support the acceptance of investment managers’ propositions
by managers and other shareholders as well as investment managers’ capacity to better
adapt their influence might be their start-up experience. DIMOV/SHEPHERD empi-
rically analysed the effect of investment manager start-up experience on the success of
their investments and found marginal support for this.480 This indicates that previous
start-up experience might be a valuable resource for investment managers when
supporting and controlling portfolio companies and might also be relevant for
influencing corporate governance.
H3.3.4: The greater the investment managers' start-up experience, the greater is the
impact of their influence on the corporate governance of portfolio companies.
Apart from the experiences and capabilities of investment managers, their

commitment might also be of importance for their impact on the corporate
governance of portfolio companies. First, the more time they invest, the better they
might understand portfolio companies, which should add to their ability to effectively
influence portfolio companies. Second, the commitment of the investment managers
might also increase the acceptance of his/her proposals among the other shareholders
and the portfolio companies’ managers.481 The commitment of the investment
managers is determined by their time availability and willingness. The time avai-
lability depends mainly on the number of investments a manager has to look after.
There are national differences to this, as RUPPEN shows in his empirical analysis. He
found that the number of board seats of one investment manager in the USA and in the
UK is comparatively higher than in Germany: 5 and 5,5, respectively, compared to
4.482 This indicates that there might be differences in the time availability of investment
managers, which could affect their impact on portfolio companies, also in regard to
479
Weimer/Pape (1999), pp. 152ff.
480
Dimov/Shepherd (2005), p. 14.
481
Ruppen (2001), pp. 54ff.; Sapienza (1992), pp. 15ff.
482
107
corporate governance. The willingness of investment managers to influence portfolio
companies is another factor determined by the relationship between them and the
managers of the portfolio companies. An empirical analysis indicates that the time
spent monitoring and consulting with a portfolio company depends strongly on the
personal fit between the investment managers and the managers of the portfolio
company.483 Based on this, it is expected that the influence of the venture capitalists is
also determined by the commitment of the investment managers.
H3.3.5: The greater the commitment of the investment managers, the greater is the
impact of their influence on the corporate governance of portfolio companies.
4.3.3 Trust
The extent of the influence on the advice function of corporate governance also
depends on mutual trust between the venture capitalists and the managers of the port-
folio companies.484 The advice of the venture capitalists can hardly be enacted against
the will of the managers. The interaction between the venture capitalists and the
managers in non-routine issues might be much facilitated if a relation of trust and
openness exists.485 The opinion of the venture capitalists might be more relevant for the
managers if they trust them. Accordingly, it can be assumed that the impact of venture
capitalists’ influence increases if the relationship between venture capitalists and
managers is trustful.
H3.4: The impact of venture capitalists’ influence is greater if their relationship with
the managers of portfolio companies is trustful.
The introduced hypotheses on the relation between a venture capitalist's abilities and
its expected impact on the corporate governance of portfolio companies are summa-
rised in Figure 14 before considering the impact of the resulting corporate governance
quality on firm value, which is analysed next.
483
484
Sweeting/Wong (1997), pp. 141 ff; c.f. Bassen (2002a), pp. 246ff.
485
Hatherly et al. (1994).
108
Impact on
Corporate
Governance
Assessment/Selec-
tion of managers
Abilities
Bonding of
Control rights managers
H3
VC's Compensation of
characteristics managers
Composition of
Trust board
Work of board
Figure 14: Relationship between venture capitalists' abilities and impact on corporate governance
4.4 Effects of Corporate Governance on Firm Value

Both underlying theoretical perspectives explain the effects of good corporate
governance on firm value, although in different ways. In the following, the two
explanations are briefly recapitulated.486
4.4.1 Theoretical Explanation

According to agency theory, effective and efficient corporate governance should
reduce agency costs that arise from diverging interests between investors and
managers. The costs, which include expenditures of the investors to bond and monitor
the managers as well as some residual losses, should be minimised with optimal corpo-
rate governance arrangements.487 Accordingly, the costs incur at the level of the
investor (bonding and monitoring expenditure) as well as at the level of the firm
(residual losses). Corporate governance might reduce the residual losses by reducing
the costs of consumption on the job and by carrying out cashflow-positive but risky
projects that would not have been realised by the managers without monitoring and
bonding by the investors.488 This should result in higher profitability and stronger
growth, thus increasing fundamental performance. Additionally, companies with low
agency risks due to good corporate governance should also be more attractive for
486
Refer to chapter 3.1.2 and 3.2.2 for more detailed explanations.
487
Jensen/Meckling (1976), pp. 308ff.; Shleifer/Vishny (1997), pp. 740ff.
488
Core (2004), p. 17; Ruppen (2001), p. 17; Schmidt (2001), p. 65.
109
investors. This is because of the prospects of better future performance but also
because of the expectations of lower costs for future measures to reduce agency risk.
Therefore, investors should value companies with good corporate governance
comparatively highly and should be willing to pay a corresponding premium.489
In contrast to this, the dynamic resource-based view does not directly ascribe the
effects of corporate governance on value to a reduction in costs but to better compe-
titiveness because of better decision making. Good corporate governance should,
according to this view, lead to informed decision making which could be a valuable
resource, in particular for growth companies with a high degree of internal and
external dynamic.490 Better management and control of a company due to the involve-
ment of experienced and capable stakeholders such as shareholders and board
members should lead to better-informed decisions that could lead to better decisions
and a better positioning in the competition. The resulting competitive advantage of a
company with good corporate governance should on one hand increase the perfor-
mance — higher profitability and stronger growth — and on the other hand increase
the attractiveness for investors and thereby the valuation of a company. 491
Consequently, according to both perspectives, good corporate governance should lead

to comparatively high firm value.492 In the following, the empirical findings on the
value creation of good corporate governance are presented in detail. The existing
research is divided according to the measure for value: The results for the relationship
between corporate governance and fundamental performance — in particular profi-
tability and growth — are described first, followed by the results that relate corporate
governance and firm valuation.493
4.4.2 Fundamental Performance

Before considering the specific findings, it can be expected that corporate governance
quality affects the fundamental performance of portfolio companies.
489
Dahlquist et al. (2002), pp. 3ff.
490
Eisenhardt/Martin, pp. 1106ff.
491
Barney et al. (2001), pp. 632ff.; Lockett/Thompson (2001), p. 744; Castanias/Helfat (1991), p. 169;
Barney (1991), p. 100ff.; Combs/Ketchen (1999), p. 869.
492
Firm value considered in the financial perspective is influenced by the performance of a company and its
valuation by investors.
493
For a literature overview of the performance effects of corporate governance refer to Coles et al. (2001),
pp. 23ff.
110
H4.1: The corporate governance quality of a company has positive effects on its
fundamental performance.
4.4.2.1 Profitability
Profitability can be measured with different variables depending on the returns and
expenditures are taken into account. In the existing studies, the following four
measures were used primarily to test a relationship between corporate governance and
profitability: return on equity, return on assets, net profit margin and earnings before
interest, depreciation and amortisation (EBITDA).
Return on equity: Many studies take return on equity into account because it is a key
measure for investors to evaluate the success of an investment. Return on equity is
calculated by dividing the earnings available for common stockholders by the average
equity of a company.494 The results are mixed, though.
BROWN/CAYLOR found in their analyses that firms with weak corporate governance
have a lower return on equity than those with good corporate governance: On one
hand, return on equity of firms in the decile with the worst corporate governance
quality — measured by the Corporate Governance Quotient developed by Institutional
Shareholder Services — are 4.86% below the industry average. On the other hand,
firms in the decile with the best corporate governance generate a mean return on equity
that is 18.98% higher than the industry average.495 An analysis for the United Kingdom
done by Deutsche Bank supports these findings: The 20% of the companies in the
sample with the highest corporate governance quality generated an average return on
equity of 15,9% in 2002, whereas the 20% of companies with the lowest corporate
governance quality had only a return on equity of 1,5%.496 Similar results also come
from DROBETZ ET AL.497 who researched the relationship in Germany. They found a
significant positive relationship between corporate governance quality measured with
a Corporate Governance Rating and the return on equity of the analysed companies.498
494
Brealey/Myers (2000), p. 829.
495
Borwn/Caylor (2004), pp. 5ff.
496
Deutsche Bank (2004), p. 43.
497
Dynamic analysis of 91 German companies listed in the stock exchange segments DAX 30, MDAX,
NEMAX and SDAX, January 1998 to March 2002; corporate governance quality measured with
Corporate Governance Index with 30 criteria; for more information on the methodology see Drobetz et al.
(2003), pp. 8ff.
498
Drobetz et al. (2003), pp. 23ff.; the authors interpret ROE here in the investors’ perspective as expected
return on investment and therefore hypothesised a negative correlation between corporate governance
quality and ROE.
111
Apart from the results from these developed countries, there is also evidence for a
positive relationship in developing countries. The study done by AMAR for 15
emerging markets indicates that the return on equity of companies with good corporate
governance is about ten points higher than the average. The positive correlation
between corporate governance and return on equity holds for 13 of the 15 markets.499
In contrast to these results, the study by GOMPERS ET AL., which received great
attention, could not prove a significant relationship between companies with strong
shareholder rights — which corresponds to good corporate governance — and return
on equity. The analysed correlation was positive but not significantly so.500 BAUER
ET AL., who did the same analysis for Europe, could not find a positive relationship
between corporate governance and return on equity either: For both the UK and the
European Monetary Union samples, they did not find any significant relationship,
positive or negative.501
Consequently, at odds with the theory, there is no clear empirical evidence of a

positive effect of good corporate governance on the return on equity of companies.
Return on assets: Measuring the performance of companies with return on assets as

an independent variable implies the perspective of all capital providers, i.e., investors
and creditors. It is calculated by dividing the earnings before interest by the average
total assets.502 It consequently includes the income for both groups.
The worldwide analysis of KLAPPER/LOVE found that firms with weaker corporate
governance have lower profits, which indicates that the positive relationship holds for
well established as well as for emerging markets, which are generally considered to
have more concentrated ownership and weaker legal environments.503 Further support
comes from ROWN/CAYLOR. Their analysis indicates that good corporate
governance is related to high return on assets. The firms in the decile with the highest
corporate governance quality have a mean return on assets that is 9,78 % higher than
the industry average.504 Similarly, CORE ET AL. found that weak corporate gover-
499
Amar (2001), p. 21.
500
Gompers et al. (2003), p. 129; in the study there is a negative correlation with the governance index but a
low level in that index corresponds to great shareholder rights and good corporate governance.
501
Bauer et al. (2003), pp. 13ff.
502
503
Klapper/Love (2002), p. 22.
504
Brown/Caylor (2004), p. 10.
112
nance results in weak operating performance measured by return on assets.505 This
indicates that weak governance is costly for companies because it decreases operating
performance.506 Consequently, it can be assumed that good corporate governance is
positively related to performance measured by return on assets. Additionally,
DEUTSCHE BANK showed a positive relationship between corporate governance and
return on assets. Here, the average difference between the 20% of companies with the
highest and lowest corporate governance quality was 23,1% in 2002.507
In contrast to these studies, BEINER ET AL. found a significant but negative relation-
ship between fulfilment of the corporate governance index and return on assets, which
they could not explain conclusively.508
This overview of the existing studies shows that the greatest part of the analyses found
evidence for a positive relationship between corporate governance and return on
assets.
Net profit margin: The net profit margin is income divided by sales. It is calculated
by dividing earnings before interest by sales.509
GOMPERS ET AL. found a significantly positive relationship between the net profit
margin and the shareholder rights of companies. They document larger capital expen-
diture by weak governance firms and suggest that this might be due to over-
investments of these companies that lead to poor performance. 510
In contrast to this, BAUER ET AL. could not find a positive relationship between
corporate governance and net profit margin: Their analysis showed no significant
relationship for the UK sample and even a significantly negative relationship for the
European Monetary Union. They consider the possible bias of accounting numbers to
be an explanation for this: It might be that badly governed companies tend to report
less conservative earnings statements.511
505
Core (2004), pp. 11ff.
506
Core (2004), p. 14.
507
508
Beiner et al. (2004), p. 33.
509
Brealey/Myers (2000), p. 828; Gompers et al. (2003), p. 129
510
Gompers et al. (2003), pp. 129ff.; Guay (2004), p. 12.
511
113
The little empirical evidence on the relationship between corporate governance quality
and net profit margin is not giving a clear picture yet.
EBITDA margin: The EBITDA margin takes into account only operative
expenditures. It is calculated by dividing earnings before interest, taxes, depreciation
and amortisation by sales.512
Only one study analysed the correlation between corporate governance and this perfor-
mance measure. DEUTSCHE BANK found for their UK sample a relationship
between corporate governance and EBITDA margin. The average spread between the
top 20% and the bottom 20% of companies in terms of corporate governance quality is
21%.513 The study indicates that a positive relationship between corporate governance
quality and the EBITDA margin might be proven empirically.
Given the theoretical evidence and the partial empirical evidence, it could be expected
that companies with good corporate governance are more profitable than companies
with poor corporate governance.
H4.1.1: The better the corporate governance quality of a company, the higher is its
profitability.
4.4.2.2 Growth
Growth of a company can be measured with many different variables referring, for
example, to sales, assets or employees.514 However, the empirical findings are rather
limited: only two studies took this dimension of firm value into consideration.
In their empirical analysis, GOMPERS ET AL. found a significantly positive relation-

ship between shareholder rights and the sales growth of a company.515 In contrast to
this study, BEINER ET AL found a significant but negative relationship between the
fulfilment of the corporate governance index and firm growth, for which they could
not provide a conclusive explanation.516
512
513
514
Kock (2002), pp. 660ff.
515
Gompers et al. (2003), p. 129.
516
Beiner et al. (2004), p. 33.
114
Consequently, the theoretical indication of a positive relationship between corporate
governance and firm growth has not been clearly proven by empirical studies. None-
theless, it could be expected that the theory holds and that better corporate governance
leads to stronger growth, directly by more cashflow-positive projects, and indirectly as
a result of a better competitiveness.
H4.1.2: The better the corporate governance quality of a company, the higher is its
growth.
4.4.3 Valuation
Several empirical analyses of the relationship between good corporate governance and
firm valuation exist. They all use Tobin’s Q as the variable measuring the market valu-
ation of the book value of a company. It is calculated by dividing the market value of a
company’s assets by the estimated replacement cost.517
KLAPPER/LOVE analysed the relationship between corporate governance quality and

Tobin’s Q for 14 countries worldwide. They found an overall positive significant
relationship and an even stronger relationship if the analysis was controlled for
different countries. This indicates that it is rather the relative than the absolute level of
corporate governance quality that is relevant. On average, an increase in the corporate
governance index of one standard deviation results in an increase in Tobin’s Q of
about 23%.518 This supports the results presented by GOMPERS ET AL. They showed
in their analyses that in the 1990s, US firms with strong shareholder rights were valued
significantly higher than those with weak shareholder rights.519 Similar results are also
proven for other regions: A positive relationship between corporate governance quality
and Tobin’s Q for Europe is shown by three studies. BAUER ET AL. showed diffe-
rences between the correlation for the sample for the European Monetary Union and
the UK. In the first, an increase in the Corporate Governance Quality — measured by
their index with 300 criteria — led to an average increase in Tobin’s Q of 0,14 %,
compared to only 0,01 % for the latter sample.520 These results are supported by the
findings of DROBETZ ET AL. BEINER ET AL. show that firms with better corporate
governance have a significantly higher firm valuation than those with bad corporate
517
518
Klapper/Love (2002), p. 21.
519
Gompers et al. (2003), p. 128.
520
115
governance. More specifically, an increase in their corporate governance codex —
ranging from 1 to 100 — of one point leads to an increase of the company’s market
capitalization of its book asset value of about 8,52% on average.521 These results are
supported by the findings of DROBETZ ET AL. The study by BLACK ET AL. for
Korea indicates that the positive relationship between corporate governance quality
and firm valuation also holds for this Asian country: An increase of the corporate
governance index — ranging from 0 to 100 — of 10 points leads to an increase in
Tobin’s of 0,064.522 However, BASSEN ET AL. who used a sample of German com-
panies and the German Corporate Governance Code as a basis for analysing the corpo-
rate governance quality could not find strong support for a positive relationship
between good corporate governance and Tobin's Q.523
This overview shows that almost all studies proved the theoretically deducted relation-
ship. Consequently, it can be expected that good corporate governance has an impact
on firm valuation, and more precisely that it is recognised by investors and therefore
leads to a higher firm valuation.
H4.2: The corporate governance quality of a company has positive effects on its funda-
mental performance.
H4.2.1: The better the corporate governance quality of a portfolio company, the higher
is its valuation.
The expected relationship between corporate governance quality and the firm value of
growth companies is illustrated in Figure 15. This concludes the theoretical analysis of
the four aspects and provides a basis for the empirical analyses that are presented in
the next chapter.
521
Beiner et al. (2004), pp. 29ff.
522
Black et al. (2003), p. 16.
523
Bassen et al. (2006a), pp. 375ff.
116
Impact on
Corporate
Governance
Assessment/Selec-
tion of managers
Bonding of Firm Value

managers
H4 Performance
Compensation of
managers
Valuation
Composition of
board
Work of board
Figure 15: Relationship between impact on corporate governance and firm value
117
5 Empirical Analyses
This chapter presents the results of the empirical analysis of the theory-based
hypotheses. First, the research concept is introduced to summarise the expected
relationships between venture capital, corporate governance and firm value before the
methods are described in detail. Then, the empirical results are presented, first for the
qualitative analysis and then in more detail for the quantitative analysis.
5.1 Research Concept

The four most-important aspects of the relationships between venture capital and
corporate governance were derived from the two research questions. With the two
underlying theories, agency theory and the dynamic resource-based view, hypotheses
were derived for those relationships in the last chapter. Figure 16 shows these relation-
ships at the highest level in an overview.
Reason
Agency theory
Risk reduction Venture Impact on

Capitalist's Corporate
Resource- Influence Governance
based view H1 H2
Assessment/Selec-
Intensity tion of managers
Value creation
Bonding of Firm Value

CG-Elements managers
Exit
H4 Performance
preparation Compensation of
managers
IPO-preparation Abilities Valuation
Composition of
Control rights board
H3
VC's Work of board
characteristics
Reporting
Trust discipline
How do venture capitalists influence the corporate What are the effects of good corporate
governance of portfolio companies? governance on the firm value of
growth companies?
Figure 16: Research concept
In the following, the individual hypotheses are summarised and presented in an over-
view. The first hypotheses concern the reasons venture capitalists influence the
119
corporate governance of portfolio companies. Agency theory predicts that the main
reason for this is the associated business and agency risk of an investment that should
be reduced by appropriate corporate governance. By contrast, the dynamic resource-
based view regards value creation by good corporate governance as the goal that
venture capitalists want to achieve with their influence. A further reason could be the
preparation of an exit as a successful sale of a portfolio company could require good
corporate governance. Finally, the reasons might change over time so that the different
approaches can be substitutive or complimentary. Figure 17 summarises the hypo-
theses that are tested in the following.
# Hypothesis
H1.1 The stronger the agency and business risk associated to an investment are the greater
is the venture capitalists’ influence on the corporate governance.
H1.1.1 The stronger the agency and business risk associated to an investment is the greater is
the venture capitalists’ influence on the assessment of managers.
the venture capitalists’ influence on the selection of the managers.
the venture capitalists’ influence on the compensation of the managers.
the venture capitalists’ influence on the bonding of the portfolio companies’ managers.
the venture capitalists’ influence on the composition of the board.
the venture capitalists’ influence on the work of the board
the venture capitalists’ influence on the frequency of reporting.
H1.2 The better the initial corporate governance quality is the greater is the venture
capitalists’ influence on the corporate governance.
H1.2.1 The better the initial corporate governance quality is the greater is the venture
capitalists’ influence on the selection process of new managers.
capitalists’ influence on the composition of the board.
capitalists’ influence on the work of the board.
H1.3 Before a potential public exit the venture capitalists increase their influence on the
H1.3.1 Before a potential public exit it is more probable that the portfolio company complies
with corporate governance codes.
H1.3.2 Before a potential publich exit it is more probable that the portfolio company has board
members with experience in listed companies.
H1.4 Agency and business risk has a stronger impact on the venture capitalist’s influence on
the corporate governance of portfolio companies at earlier financing rounds than at later
financing rounds.
Figure 17: Overview of hypotheses about the relationship between venture capitalists' reasons and
influence on corporate governance
120
The second expected relationship is that venture capitalists' influence leads to better
corporate governance of the portfolio companies. Although both theories agree on this,
they focus on different corporate governance elements. Whereas agency theory centres
on the monitoring and bonding function of corporate governance, the dynamic re-
source-based view concentrates on the advice function. This is mirrored in the follow-
ing hypotheses.
# Hypothesis
H2 The venture capitalists' influence has an impact on the portfolio companies' corporate
governance
H2.1 The venture capitalists' influence has a positive impact on the assessment and
selection of managers.
H2.1.1 The stronger the venture capitalists’ influence is the more likely is the assessment of
the managers.
H2.1.2 The stronger the venture capitalists’ influence, the more efficient is the assessment of
the management.
H2.1.3 The stronger the venture capitalists’ influence, the more likely managers are to be
replaced.
H2.1.4 The stronger the venture capitalists’ influence, the better is the managers' selection
process.
H2.2 Venture capitalists' influence has a positive impact on the bonding of managers.
H2.3 The venture capitalists' influence has a positive impact on the compensation of
managers.
H2.3.1 The stronger the venture capitalists’ influence, the higher is the proportion of the
variable compensation.
H2.3.2 The stronger the venture capitalists' influence, the more likely is the use of variable
compensation parts linked to mid- and long-term goals.
H2.3.3 The stronger the venture capitalists’ influence is the lower is the cash compensation of
the managers.
H2.4 The venture capitalists' influence has an impact on the composition of the board.
H2.4.1 The stronger the venture capitalists’ influence is the greater is the proportion of
independent members in the board.
H2.4.2 The stronger the venture capitalists’ influence, the stronger are the experiences of the
board.
H2.5 The venture capitalists' influence has a positive impact on the work of the board.
H2.5.1 The stronger the venture capitalists’ influence, the more frequently board meetings take
place.
H2.5.2 The stronger the venture capitalists’ influence, the better prepared board meetings are.
H2.5.3 The stronger the venture capitalists’ influence is the more involved is the board in
strategic decision making.
121
# Hypothesis
H2.6 The venture capitalists' influence has a positive impact on reporting discipline.
H2.6.1 The stronger the venture capitalists’ influence, the more frequent is the portfolio
H2.6.2 The stronger the venture capitalists’ influence, the more timely is the portfolio
H2.6.3 The stronger the venture capitalists’ influence, the more comprehensive is the portfolio
H2.6.4 The stronger the venture capitalists’ influence, the more accurate is the portfolio
Figure 18: Overview of hypotheses about the relationship between venture capitalists' influence and the
quality of corporate governance
The third group of hypotheses addresses the abilities required of venture capitalists to
affect corporate governance. Agency theory considers the ownership rights as crucial
for the venture capitalists to push through their goals. The dynamic resource-based
view focuses instead on the characteristics of venture capital firms and investment
managers that could cause changes in corporate governance. Moreover, the second
perspective also regards the trustfulness of the relationship between managers of port-
folio companies and venture capitalists as important for the effectiveness of the
venture capitalist’s influence. The corresponding hypotheses are presented in Figure
19.
# Hypothesis
H3 The abilities of venture capitalists have an impact on the corporate governance of
H3.1 The control rights of venture capital firms have a positive impact on the corporate
H3.1.1 The stronger the venture capitalists' control right rights, — in terms of ownership rights
and board seats — the stronger is their influence on the corporate governance of
H3.1.2 The stronger the venture capitalists' control rights, the greater is the impact of their
influence on the elements related to the monitoring function of corporate governance.
influence on the elements related to the bonding function of corporate governance.
122
# Hypothesis
H3.2 The characteristics of venture capital firms have positive impact on the corporate
H3.2.1 Independent venture capital firms’ influence has a greater impact on the corporate
governance of portfolio companies than that of corporate venture capitalists and bank-
related and governmental venture capitalists.
H3.2.2 The more investment experience a venture capital firm has, the greater are the effects
of its influence on the corporate governance of portfolio companies.
H3.2.3 The greater the international experience of the venture capital firms, the greater are the
effects of their influence on the corporate governance of portfolio companies.
H3.2.4 The greater the reputation of a venture capital firm, the greater are the effects of its
influence on the corporate governance of portfolio companies.
H3.3 The characteristics of investment managers have positive impact on the corporate
H3.3.1 The greater the investment managers' experience in the portfolio company’s industry,
the greater is the impact of their influence on the corporate governance of portfolio
companies.
H3.3.2 The greater the investment manager’s experience in the portfolio company’s industry is
the greater is the impact of his/her influence on the corporate governance of portfolio
companies.
H3.3.3 The greater the investment managers' international experience in the venture capital
industry, the greater is the impact of their influence on the corporate governance of
H3.3.4 The greater the investment managers' start-up experience, the greater is the impact of
their influence on the corporate governance of portfolio companies.
H3.3.5 The greater the commitment of the investment managers, the greater is the impact of
their influence on the corporate governance of portfolio companies.
H3.4 The impact of the venture capitalists influence is greater if their relationship with the
managers of portfolio companies is trustful.
Figure 19: Overview of hypotheses about the relationship between venture capitalists' abilities and the
quality of corporate governance
Finally, the fourth group of hypotheses relates the corporate governance of the
portfolio companies to their firm value, measured by fundamental performance and
valuation of the companies. Both agency theory and the dynamic resource-based view
predict positive effects of corporate governance on firm value, as detailed in the last
chapter. The following table presents the relevant hypotheses.
123
# Hypothesis
H4.1 The corporate governance quality of company has effects on its fundamental
performance.
H4.1.1 The better the corporate governance quality of a company is, the higher is its
profitability.
H4.1.2 The better the corporate governance quality of a company is, the higher is its growth.
H4.2 The corporate governance quality of company has effects on firm valuation.
H4.2.1 The better the corporate governance quality of a portfolio company is, the higher is its
valuation.
Figure 20: Overview of hypotheses about the relationship between the quality of corporate governance
and firm value
The research comprises a qualitative as well as a quantitative analysis to ensure both

an in-depth understanding of the research topic and generalisable results. This
approach also prevents single method bias.524 In the next section, the results of expert
interviews are presented before the results of the survey are introduced in more detail.
5.2 Qualitative Analysis

After laying the theoretical foundations, a qualitative analysis in the form of in-depth
interviews was conducted. This was done for three reasons. First, the interviews were
used to compare the findings from the theoretical analysis with the common practice.
Second, they ensured that a comprehensive picture of the relationship between venture
capital and corporate governance was gained comprising all important factors. Third,
they helped to operationalise the theory-based hypotheses in order to ensure that the
quantitative analysis well captures the ideas of the research concept.
For the analysis, 19 semi-structured interviews were conducted with venture

capitalists, CEOs of portfolio companies and other experts. In order to ensure a
comprehensive picture, interviews were done in Germany, Belgium, the United King-
dom and Luxembourg as well as with different types of venture capitalists and port-
folio companies at different development stages. The interviews were done between
July and October 2005 either personally or by telephone. They all addressed the two
research questions with the four aspects of the research: the reasons for the venture
capitalists’ influence, its impact on corporate governance, the abilities of the venture
capitalists to influence the portfolio companies’ corporate governance, and the effects
524
Blaikie (1991), pp. 115 ff.; Johnson/Onwuegbuzie (2004), pp. 14ff.; Fielding/Schreier (2001).
124
of good corporate governance on firm value. Figure 21 shows the conducted inter-
views in an overview.
Venture Capitalists Portfolio Companies Other Experts
4 in Germany 3 in Germany 1 lawyer in Germany

• 2 independent VCs • 1 small successful early stage
• 1 CVC company 1 consultant in UK
• 1 governmental VC • 2 formerly fast growing
companies, now after 1 funds-of-funds investor in
3 in Belgium restructuring Luxembourg
• 2 independent VCs
• 1 financial Institution-related 2 in Belgium
VC • 1 startup
• 1 buyout
2 in UK
• 2 independent VCs 2 in UK
• 2 startups
Figure 21: Overview of interviews
To begin with, the findings related to the research question about how venture
capitalists influence the corporate governance of portfolio companies are
presented. In regard to the reasons, the interviews with the venture capitalists largely
support that agency risks are a main concern for them and that they influence the
corporate governance of their portfolio companies accordingly. Indicators for this risk
are the perceived bad information basis and a conflict of interest with the managers.
Furthermore, before a potential exit of a portfolio company, the influence on corporate
governance is increased. However, corporate governance as a source of value creation
is only recognised by some of the interviewees. The interviewees supported the hypo-
thesis that their influence changes over time during an investment, but the specific
factors of this change could not be revealed in the interviews. In contrast to this, the
venture capitalists stated that their approaches regarding the corporate governance of
portfolio companies are rather similar. Regardless of the origination and type of the
venture capitalists, they all seem to influence the six corporate governance elements
introduced before: assessment, selection, bonding, and compensation of managers;
composition and work of boards; and reporting discipline. Interviews with a
specialised lawyer and a consultant supported this notion. According to them, the
venture capitalists’ influence is mainly determined in the contracting phase, and the
contracts are largely standardised so that the resulting influence on corporate gover-
nance by the investors is rather similar. The focus of the influence might change over
time during an investment: Whereas reporting is more important in the early phase of
an investment, management assessment and selection gets more important in later
125
stages when the demands on managers increase. Generally, a positive impact on
corporate governance quality is expected. In regard to the required abilities, venture
capitalists consider control rights important to accomplish changes in corporate gover-
nance. Moreover, several interviewees also pointed to the relevance of a trustful
relationship with the managers of the portfolio companies because they might be able
to effectively affect the portfolio companies only if the managers trust them. This
argument contradicts the notion that corporate governance is enforced when venture
capitalists perceive a bad information basis.
Similarly, the findings from the interviews with the portfolio companies support that
the venture capitalists are important drivers of corporate governance development. In
contrast to the interviewed venture capitalists, the managers of the portfolio companies
recognised differences between the influence of different venture capitalists, in terms
of both extent and direction. However, the hypothesised factors for such differences
could not be well tested during the interviews. In most of the cases, the interviewees
perceived that the venture capitalists’ influence improved corporate governance. The
managers of the portfolio companies distinguished between the support they received
from different venture capitalists, which was traced back to different approaches and
experiences of the investors. Correspondingly, the results from the interview with a
consultant revealed different profiles of venture capitalists that should lead to
differences in their impact on the corporate governance of portfolio companies. In
particular, the most professional investors are said to have a comparatively strong
influence. This is supported by an interview with a fund-of-fund investor in which
factors such as number of funds, size of funds and reputation were named as indicators
of the professionalism of a venture capitalist. Apart from that, the interviewed
managers of portfolio companies stressed the importance of the venture capitalists'
control rights for the extent of their influence on corporate governance. The control
rights determine the negotiation power of the venture capitalists and the managers of
the portfolio companies and might prevent the investors from pushing through strict
burdens. All interviewees realised an improvement of corporate governance because of
the venture capitalists' influence, though the extent differed between the investors and
the companies.
The second research question is related to the influence of corporate governance on

firm value. Referring to this relationship, the majority of the interviewed venture
capitalists reported positive effects because of cost reductions. By their influence,
126
corporate governance costs at the portfolio companies could be prevented, which they
documented with examples. The impact on the growth of portfolio companies was
recognised only indirectly through better decision making. However, specific
examples were not given. By contrast, only a few investors supported a relationship
between good corporate governance and the valuation of portfolio companies. These
venture capitalists considered that new investors would value better historic infor-
mation on the portfolio companies' development while they would calculate a discount
on the firm value should the provided information be of poor quality. Generally, the
interviewees supported the notion that good corporate governance increases firm
value. But they also stressed that bad corporate governance does not inevitably lead to
bad performance. These findings correspond to the results of the interviews with the
managers of portfolio companies. Generally, they also supported a positive relation-
ship between corporate governance and firm value, but they argued that this relation-
ship is indirect, for example by providing a better information basis and by advice
from board members and better decision making. Furthermore, the interviewees
stressed that good corporate governance in the case of growth companies might not be
well assessed by the criteria of corporate governance codes because they neglect the
particular and changing requirements of these companies. The majority of both venture
capitalists and the managers of portfolio companies doubted that the effects of good
corporate governance on firm value could be shown empirically.
The results from the interviews, by and large, support the theory-based hypotheses.
However, the hypotheses on the differences of venture capitalists' influence at diffe-
rent times in the development of portfolio companies or due to the abilities of the
venture capitalists could not be supported because the number of interviews was too
limited.
The qualitative analysis also indicated that two elements that are less relevant in the
theoretical analysis are relatively important in practice: exit preparation as a reason to
influence corporate governance and the trustfulness of the relationship between
venture capitalists and the managers of portfolio companies. Venture capitalists'
actions are generally targeted at a successful exit from their investment. They realise
the importance of good corporate governance for the success of an exit because poten-
tial investors fear risks that might arise from bad governance. Particularly in the case
of an IPO, there are high requirements for the professionalism of corporate governance
from the legislature, the stock exchange and potential investors. Furthermore, venture
127
capitalists realise that the success of their investment is largely dependent on the co-
operation of the portfolio companies' managers. First, changes to the development of
the portfolio company can only be effective if the managers support them because they
make most of the decisions in the company and implement the actions accordingly.
That means that the managers might only be willing to take decisions and actions pro-
posed by the venture capitalists if they trust them. Additionally, the venture capitalists
cannot monitor all decisions and actions by the managers, so they must also be able to
trust the managers of the portfolio companies. All in all, with the reinforcement of the
two aspects, the hypotheses derived from theory seem to be comprehensive.
The interviews were used to align the theoretical analysis with the needs of a
quantitative analysis. In order to test the theory-based hypotheses, it is required to
operationalise all concepts to variables that can be queried in a survey. This was faci-
litated by the interviews that provided deeper knowledge on the practice of the
relationship between venture capitalists and portfolio companies in different European
countries. In particular, there are three important aspects that were derived from the
findings of the qualitative analysis. First, the venture capitalists and portfolio
companies agreed that the necessity of elaborate corporate governance structures and
processes depends largely on the specific characteristics of a portfolio company.
Therefore, the effectiveness of corporate governance cannot always be definitively
measured by the compliance with general corporate governance elements. This is in
contrast to general corporate governance research, which generally uses standardised
corporate governance ratings to survey corporate governance quality. But it should be
noted that that research is almost entirely focussed on large and established companies,
whereas this analysis is looking at growth companies in the process of development.
Accordingly, the quantitative analysis uses a second measure for the quality of
corporate governance that is based on a self-assessment of the managers of the
portfolio companies as it can be expected that they can best evaluate whether the
corporate governance of a company is adequate for its specific development stage.
Secondly, it was found that the analysis of the development of corporate governance in
the portfolio companies can best be pursued by analysing its development between the
financing rounds of the venture capitalists. At these times, greater changes are to be
expected for two reasons: The venture capitalists negotiate or renegotiate their rights
and changes to the portfolio companies' structures and processes before an investment
is done. In the case of a second or third financing round, the earlier development of the
company is taken into account during the renegotiations so that venture capitalists'
128
position can be enforced or stay stable. Consequently, the questionnaire for the
quantitative analysis measures corporate governance quality and the influence of the
venture capitalists at the points of time of a financing round. Thirdly, the effects on
firm value for the analysed growth companies cannot be measured in the same way as
it is done in traditional corporate governance research. This is due to the fact that those
companies often do not yet generate positive results, especially if they are still in an
early development phase. Furthermore, the most common measure for firm value,
Tobin's Q, cannot be used for these companies because a market value is unavailable.
Hence, the analysis must use measures specific for the venture capital business. Apart
from measures for growth and profitability, the survey therefore takes into account
measures for valuation multiples that are often used by venture capitalists to calculate
the firm value of portfolio companies. Numerical measures might not always be
suitable due to strong development in growth companies. Negative results might be
inevitable when pursuing growth potentials and therefore expected in the companies'
business plans. Accordingly, negative results cannot always be interpreted as bad
performance. Because of this, relative measures are used in this thesis as well those
that compare the companies' performance to their competitors’ and their own business
plans.
Hence, the findings of the qualitative analysis basically support the theoretically
derived hypotheses. The results of the interviews were used to verify the research
concept and to align the questionnaire for testing the hypotheses to practice. In the
following section, the details of the survey are introduced.
5.3 Methods of the Quantitative Analysis

After ensuring an in-depth understanding of the research topic with the theoretic and
qualitative analysis, a quantitative analysis was done to achieve generalisable results.
In the following, the data sources and the variables for testing the hypotheses are
introduced.
5.3.1 Data Sources

The information for the quantitative analysis was collected from two sources: a survey
and a database. The combination provided a unique and relatively comprehensive data
set.
129
5.3.1.1 Survey
The quantitative analysis was conducted by means of a pan-European survey of
venture capital-financed portfolio companies. This section describes the details of the
survey: the questionnaire, the sample, and the execution.
Given the national differences in corporate governance, the questionnaire had to be

adapted to suit portfolio companies with one-tier and two-tier board systems. This
relates in particular to questions on board structure. Consequently, there were two ver-
sions of the questionnaire that differed in the number of questions and to the wording
of some questions. The latter difference relates to the term used for the boards: The
questionnaire for companies with a one-tier system used the term board whereas the
version for companies with a two-tier system used supervisory board. Because the
questions about board members were targeted at members who are not managers of the
company, the two versions used the terms non-executive members of the board and
members of the supervisory board, respectively.
The questionnaire included questions in five areas: information about the portfolio
company, information about the corporate governance of the portfolio company
(including information about the six corporate governance elements), information
about the portfolio company’s firm value, and information about the venture
capitalists. Table 1 shows the number of questions for each area. It indicates that the
questionnaire for portfolio companies with a one-tier systems included 104 questions,
which is two more than the one for companies with a two-tier system. This is because
questions about the number of independent non-executive board members and dual
leadership were asked only in the first version.
Number
Area of
questions
Information about portfolio companies 17
Information about venture capitalists 11
Assessment and selection of managers 9
Bonding of managers 5
Information
Compensation of managers 6
about
Composition of board 14/16
corporate
Work of board 10
governance
Reporting discipline 11
Other 5
Firm Value 14
Total 102/104
Table 1: Questions by areas
130
In order to track the development of the analysed portfolio companies, a great number
of questions in the questionnaire asked for several answers for different points in time.
Altogether, five measuring times correspond to the findings of the qualitative study:
the time before the first financing round (t=0), the time after the 1st financing round
(t=1), the time after the 2nd financing round (t=2), the time after the 3rd financing round
(t=3) and today (t=4). In particular, the questions referring to corporate governance
and firm value as well as those about the venture capitalists were asked for the first
four measuring times, if possible. The questionnaire was adapted because the analysed
companies are at different points in their development and had different numbers of
financing rounds. Hence, there were three versions of the questionnaire available
depending on the number of financing rounds of the portfolio companies: Companies
with only one financing round were asked to answer the questions for two measuring
times (before the first financing round and after the first financing round); companies
with two financing rounds answered the questions for three measuring times (addi-
tionally after the second financing round), and companies with three or more financing
rounds answered the questions for four measuring times (additionally after the third
financing round). This enabled tracking of changes to the corporate governance from
founding until after the third financing round. The questions about the portfolio
companies generally asked for information at two times: before the first financing
round and today. All companies were to provide this information. The last measuring
time was used as a substitute for the situation after the last financing round to simplify
answering the questionnaire.
Another distinctiveness of the questionnaire was the fact that some information was
requested in two ways. The questionnaire takes into account that the analysed portfolio
companies are generally in the process of development, which might make it difficult
to assess the appropriateness of corporate governance for the company in its current
situation, on one hand, and the success of its general and financing development, on
the other hand. Therefore, information about the companies’ corporate governance and
firm value was gathered using criteria and self-assessment. In these cases, some ques-
tions asked how well relevant criteria were fulfilled at a measuring time, and addi-
tional questions asked for a self-assessment by the respondent of how appropriate the
corporate governance element was at the same measuring time, i.e., how well the
companies performed at a measuring time. This allowed the use of different measures
to assess the quality of corporate governance and the success of the companies'
131
development. Figure 22 shows for which measuring times the information on the
different areas was requested and what form of assessment was used.
Information Type of answer Measuring times

collected
with Self-
Assesment
assessment t=0 t=1 t=2 t=3 t=4
questionnaire with criteria
by respondent
Basic information
about portfolio
companies
X X X
Performance data
of portfolio
comapnies
X X X X X X X
Characteristics of
VC investment
manager
X X X X X X
Corporate
governance quality X X X X X X X
VC's influence on
corporate
governance
X X X X X
Figure 22: Overview of information collected with questionnaire
Depending on the questions, there were different answer possibilities. The

questionnaire included open-ended and close-ended questions. The open-ended
questions primarily had numeric answers. The close-ended questions had different
formants: Some of the questions were dichotomous (e.g., Yes/No/NA), whereas others
had ranked answer possibilities (e.g., ++, +, o, –, – – or a continuum from very strong
to no influence where not every answer possibility was labelled). A few questions had
a set of specific answers from which the respondents could chose (e.g., greater
importance of fixed compensation, greater importance of variable compensation, equal
importance). The mixture of question formats delivered precise information where
necessary and less-detailed information in other areas. This facilitates responding to
the questionnaire but ensures a high degree of detail for specific areas. To ensure the
adequacy of the questions, a pre-test with five CEOs of portfolio companies and
investment managers of venture capitalists from Germany, Belgium and the United
Kingdom was conducted between 10 November and 24 November 2005. The respon-
dents tested whether all questions were well comprehensible and that the answer possi-
bilities were clear and complete. According to the feedback of the test persons, the
wording and answer possibilities of some of the questions was adapted. The
132
questionnaire was prepared as an online questionnaire to facilitate answering for the
respondents as well as to allow the invitation of a great number of participants. The
final questionnaire with all answer possibilities is attached as Annex 1.
In order to ensure a broad basis for the analysis, the most comprehensive sample of
European venture capital-financed companies was collected. Extensive investigations
revealed that the VentureXpert database from Thomson Financial offers the most
complete set of European portfolio companies, so this database was used for the
sample of the survey. It was verified whether the portfolios of several venture
capitalists are completely included in the sample, and it was found that only a very few
portfolio companies were missing. All portfolio companies that met the following four
criteria were included in the sample:
Locations in Europe
Still active at the cut-off date (to prevent including companies that do not exist
anymore525)
Received at least one financing round between 1 January 2001 and the cut-off date
(this period ensures that all companies had at least one financing round after the
new economy bubble burst in 2000)
In one of the following development stages at the time of at least one financing
round: seed, start-up, early stage, first stage, other early stage, expansion, second
stage, other expansion, third stage, other later stage, bridge, leveraged buyout (i.e.,
growth companies of early and late stages were included in the sample526).
At the cut-off date, 30 November 2005, the initial sample included 6.062 companies,
of which 65 were double entries. Additionally, for 1.386 of these companies, no
contact details were available. The sample was completed by 14 portfolio companies
for which company details were provided by venture capitalists.527 Hence, the original
sample comprised 4.496 venture capital-financed portfolio companies that were
525
It should be noted that this might lead to a survival bias of the analysis because unsuccessful portfolio
companies that ceased to exist before the cut-off date are not included in the sample; this limitation is
discussed in section 6.2.1.
526
This follows the American definition of venture capital. However, the importance of late stage companies
in the empirical analysis is limited due to the small number of cases.
527
59 professional venture capitalists were asked to provide company details on their current portfolio
companies. These venture capitalists were selected according to criteria for investment success and
reputation. Four of the contacted venture capitalists provided information on their portfolio companies.
133
contacted. The invitation to the survey was sent to the CEO of the portfolio companies
by email if the personal email address was available. This was only possible in 135
cases. The other 4.503 CEOs of the portfolio companies were invited by fax. Due to
problems with wrong addresses,528 only 3.505 invitations could have been delivered to
the portfolio companies, which is the basis for the calculation of the response rate.
This sample includes portfolio companies from 35 countries, with the biggest number
of contacted companies in the United Kingdom, France and Germany. The following
table shows the distribution of contacted portfolio companies by country. The
invitations were sent out between 1 and 7 December 2005, a reminder was sent to the
companies that had not started the survey after ten days. Another reminder was sent to
the companies that had started but not completed the survey after another ten days.
The invitation and the reminders included the Internet address of the online
questionnaire and an individual access code that ensured that only the contacted
portfolio companies were able to answer the questionnaire. Furthermore, it meant the
answers from the questionnaire could be combined with other information on the
portfolio companies from the VentureXpert database.
528
Data quality was checked, and in many cases the addresses were corrected manually. Accordingly, it can
be expected that a relatively large proportion of the companies that could not be reached might not exist
anymore. This is also confirmed by my answers from addressees that received the invitation incorrectly.
134
Contacted Contacted Contacted Invitations
Company nation companies companies companies that reached
by fax by e-mail total respondents
France 853 35 888 779

Netherlands 208 2 210 184
Belgium 139 3 142 126
Luxembourg 6 1 7 4
France/BeNeLux total 1.206 41 1.247 1.093
United Kingdom 1.032 21 1.053 859

Ireland 128 4 132 106
United 1.160 25 1.185 965
Kingdom/Ireland total
Finland 312 14 326 257
Sweden 267 7 274 218
Denmark 178 18 196 171
Norway 112 9 121 99
Iceland 2 0 2 1
Faroe Islands 1 0 1 0
Northern Europe total 872 48 920 746
Germany 556 7 563 445

Switzerland 106 2 108 85
Austria 89 1 90 80
Germany/Austria/ 751 10 761 610
Switzerland total
Spain 173 0 173 141
Italy 98 1 99 54
Portugal 47 1 48 42
Greece 11 0 11 8
Croatia 8 0 8 2
Cyprus 4 0 4 1
Slovenia 3 0 3 2
Turkey 3 0 3 2
Macedonia 1 0 1 1
Southern Europe total 348 2 350 253
Poland 56 2 58 51
Hungary 39 0 39 29
Russia 22 0 22 11
Czech Republic 12 0 12 7
Bulgaria 7 0 7 5
Slovakia 5 1 6 5
Latvia 5 0 5 3
Lithuania 5 0 5 4
Romania 4 0 4 2
Estonia 3 0 3 3
Serbia and Montenegro 1 0 1 0
Eastern Europe total 159 3 162 120
Grand total 4.496 129 4.625 3.787
Table 2: Original sample of survey by nation
By 24 February 2006, the cut-off date of the survey, 283 of the contacted portfolio
companies had started to complete the online questionnaire and 139 of those
companies completed the survey. That equals a response rate of 3,7%, which is
135
comparable to other similar analyses in the field of venture capital research.529 Figure
23 shows the calculation of the response rate in an overview.
Ø 3,7 %
4.625/3.787 3,3 % 139

100% 3% 3%
8%
5,1 %
9%
90%
80%
3,9 %
19% 19%
70% x%
60% 20% 5,4 % Response Rate

29%
Eastern Europe
50%
Southern Europe
40% 23% 2,4 %
Germany/Austria/
15%
30% Switzerland
20% Northern Europe

27% 3,2 % 25% UK/Ireland
10%
France/BeNeLux
0%
Original Sample Respondents
Figure 23: Comparison of original sample and respondents
5.3.1.2 Database
The identification of the respondents by means of an individual access code meant
information collected through the questionnaire could be complemented with infor-
mation from the VentureXpert database. In particular, the database includes infor-
mation on the portfolio companies' business and investment history as well as informa-
tion on the venture capital firms and their investments. Apart from that, an online route
planner530 was used to calculate the distance between the venture capitalists and the
portfolio companies. As introduced before, it is expected that the lead venture
capitalist exerts the greatest influence among the invested venture capitalists.531 Hence,
the information about the venture capitalist related to the lead-venture capitalists in a
specific financing round. The respondents had to indicate for every financing round
which venture capitalist was the lead-investor. In the tables of the next section, it is
noted when the data were not collected from the questionnaire but from the database.
529
For an overview refer to Dennis (2003), pp. 279ff.
530
Web address of the routeplanner: http://routing.msn.de
531
Wright/Lockett (2003), pp. 2092ff.
136
5.3.2 Variables
The following briefly introduces the response, explanatory and control variables used
for the quantitative analysis of the four aspects. In the tables in the annex, the variables
are described and their scale, possible values and sources are specified.
5.3.2.1 Reasons
Response variables
The response variable for the hypotheses on the reasons is the venture capitalists’
influence on the corporate governance of the portfolio company (interval scale).
Measures are available for the six corporate governance elements and are
aggregated to indexes for the overall influence as well as for the influence on the
elements that have a monitoring, bonding and advice function, according to the
explanations in section 2.2.3. The respondents were asked to rate the strength of the
venture capitalists’ influence after they answered the questions on the corres-
ponding corporate governance elements on a four step continuum between "no
influence" and "very strong" influence.
Explanatory variables
There are three explanatory variables for these hypotheses. First, the index for
agency and business risk includes measures for these risk types. The items for
agency risk include measures for managerial ownership (ratio scale), portfolio
company age (nominal scale), specificity of the business (interval scale), impor-
tance of intangible assets (interval scale), degree of technology of the product
(interval scale), and number of years CEO worked for the portfolio company
(nominal scale). The items for business risk include measures for the degree of
dynamics of the environment (interval scale), attractiveness of the market (interval
scale), number of products of the company (ratio scale), start-up experience of the
top-management team (interval scale), and functional experience of the top-
management team (interval scale). These measures were used in several studies
before so it can be expected that they are reliable.532
The second independent variable is the quality of corporate governance in the

previous period. Following the dynamic resource-based view that a good resource
532
E. g. Barney et al. (1989); Barney et al. (1994); Sapienza/Gupta (1994); Fredriksen/Klofsten (2001); Fiert
(1995).
137
endowment should cause venture capitalists to influence corporate governance, the
corporate governance quality indexes are used here.
The third variable is a dummy variable that indicates whether, at a specific mea-
suring time, an IPO was planned. In that case, the venture capitalist should, accor-
ding to the hypotheses, influence corporate governance in order to prepare the exit.
Control variables
In order to account for other effects that might influence the response variables but
that are not related to the theory-based hypotheses, control variables are introduced.
They include the size of the company (measured by the number of employees), the
location (in terms of European regions) and the distance between the venture
capitalist and the portfolio companies (measured in kilometres).
In the table in Annex 2 the variables for testing the hypotheses on the reasons for the
venture capitalists to influence the corporate governance of portfolio companies are
described.
5.3.2.2 Effects on Corporate Governance Quality

Response variables
The response variable corporate governance is collected in the survey in two ways.
First, there is a self-assessment of the corporate governance quality by the respon-
dent for each corporate governance element (interval scale). These assessments are
summed up in indexes for the three corporate governance functions533 as well as for
all elements (ratio scale). Besides this, the corporate governance quality is
measured by means of criteria for all elements. They are included in the indexes for
the corporate governance elements, the corporate governance functions and the
overall corporate governance quality (all ratio scale). Corresponding to the results
from the theoretic and qualitative analyses, the analysed criteria are those that are
generally influenced by the venture capitalist.
Figure 24 shows the correlation of the two corporate governance measures. The
means of the overall corporate governance quality measured by self-assessment
and measured by criteria are not strongly correlated, although the values for the
four measuring times are at similar levels.
533
138
100%
quality
0,50*** 0,26
0,31***
75% Criteria
0,22** Self-assessment
50%
25%
Correlation of
two measures
for all cases
0%
t=0 t=1 t=2 t=3
Figure 24: Comparison of two measures for corporate governance quality
The explanatory variables related to these hypotheses concern the strength of the
venture capitalist's influence. As explained in section 5.3.2.1, there are variables for
each corporate governance element but also indexes that combine them.
Control variables
The corporate governance quality might be influenced strongly by the development
stage, the location and the size of the portfolio company. Apart from that, the
venture capitalists’ abilities can have a significant impact on the corporate gover-
nance quality, as the hypotheses predict. Hence, these four variables are taken into
account when testing the hypotheses.
An overview of the individual variables is presented in Annex 3.
5.3.2.3 Abilities
Response variables
The response variable for these hypotheses is the portfolio company's corporate
governance quality. In particular, the corporate governance indexes that are
determined by both the self-assessment of the respondents and the assessment by
means of criteria for the fulfilment of corporate governance elements. These
variables are explained in detail in section 5.3.2.2.
The explanatory variables linked to the hypotheses on the impact of the venture
capitalist's abilities are associated with three factors. The control rights of the
139
venture capitalist are measured by its ownership share in the portfolio company
(ratio scale) and by its board seats (dichotomous: yes or no). The abilities of the
venture capitalist depend on the lead venture capital firm's characteristics and on
the abilities of its investment manager in a specific portfolio company. Factors for
the abilities of the venture capital firm include the type of investor (dichotomous:
independent or not), its investment and international experience (both interval
scale) and its reputation (derived from its presence in industry news and events;
dichotomous: strong or weak presence). Similarly, the abilities of the investment
manager include experience and his/her commitment, which is measured by the
number of contacts with the managers of the portfolio company (ratio scale). Third,
the trust between the venture capitalist and the portfolio company's managers is
operationalised in the survey by the respondent’s assessment of how trustful the
relationship was at the measuring times (interval scale).
Control variables
The control variables for the impact of the venture capitalist's abilities include,
apart from the development stage, the size and location of the portfolio company
and the strength of the influence of the venture capitalist. This is done because the
influence by the venture capitalist is considered the main other factor affecting
corporate governance quality. The operationalisation of this variable was detailed
in section 5.3.2.2.
Annex 4 includes a table with the information on all variables for this part.
5.3.2.4 Effects on Firm Value

Response variables
In this research, firm value as the response variable must be operationalised
differently from the corporate governance research on public companies because of
the very limited data available. It is therefore traced back to basic factors of firm
value. On one hand, the firm performance is measured by variables for the funda-
mental performance of the firm, in particular profitability and growth. The growth
rates are collected for employees, sales and cashflows allowing for companies at
different development stages that might or might not generate sales already (ratio
scale). Profitability as the second influence factor for firm performance is similarly
measured at different levels (ratio scale). The ratios EBITDA margin, net profit
margin, return on equity and return on assets are collected in the survey (ratio
140
scale). On the other hand, the valuation of a portfolio company also influences its
firm value. Corresponding to the practice in the venture capital industry, the
questionnaire asked for changes in the multiples used for valuation by investors
between two financing rounds. To make allowance for differences that might result
from different development stages, the changes of three multiples are collected: the
changes of the sales, the cashflow534 and the EBITDA multiple (ratio scale). Apart
from this specific information, the questionnaire also asked for respondent
assessments. They were asked to evaluate the impact of good corporate governance
on the performance and valuation of their companies (interval scale). Moreover,
they were asked to provide relative measures of firm value: the competitiveness of
their companies and the change in valuation between two financing rounds (inter-
val scale).
The explanatory variables associated with the hypotheses about the influence of
corporate governance quality on firm value are the variables for corporate gover-
nance that have been introduced before. Again they are used at different levels and
in two forms: self-assessment and assessment by criteria.
Control variables
Further variables with an expected influence on firm value are size, development
stage and location. Moreover, the industry of the portfolio company can determine
firm performance and valuation, so this was taken into account as well.
All variables that have been used in the analysis are described in Annex 5.
5.3.3 Statistical Methods

The data collected during the survey were analysed with uni- and multivariate
statistical methods. Descriptive analyses were carried out on the explanatory and
response variables before the hypotheses derived in chapter 4 were tested using sophis-
ticated statistical techniques. The following paragraphs introduce the methods that
were used in this research.
534
The cashflow multiples could not be used for statistical analyses because too few respondents provided
this information.
141
5.3.3.1 Descriptive Analyses
In a first step, basic information on the collected data was gained by descriptive
analyses. For all variables of the research, the following general information was
determined: the number of observations ("N"), the minimum value of all observations
("Min"), the maximum value of all observations ("Max"), the arithmetic mean of all
observations ("Mean"), and the standard deviation of all observations ("Std. Dev.").
This information was gained for all measuring times, i.e., for up to four points in time
depending on the variable. As the observations represent a time series, the develop-
ment of the variables was analysed. In the expectation that the observation of a
measuring time depends on the observation of the preceding measuring time, t-tests of
paired samples were carried out using SPSS 13.
A paired t-test compares the means of two variables by computing the difference
between the two variables for each case. It is tested if the average difference is signifi-
cantly different from zero (null hypothesis). The equation of the t-test is:
D
t
sD
n
where :
D x1 x 2
and xn are the observations at a measuring time and sD is the standard deviation of the
differences between x1 and x2. D is normally distributed with a mean of 0. t tests the
null hypothesis that the mean difference D between the two observations is 0. Conse-
quently, the difference of the observations at the two measuring times is significant if
the null hypothesis is refuted.535
The results of the descriptive analyses are presented in figures for the most important
variables and in tables that include information on the observations of all variables.
5.3.3.2 Multivariate Analyses

To test the hypotheses, multivariate analyses were carried out. As the descriptive infor-
mation indicates, the data gained from the survey are characterised by time-dependent
explanatory and response variables. This means that the observations from the
535
Janssen/Laatz (2002), pp. 316ff.
142
different measuring times are not independent; observation at a later measuring time
can be dependent on the observation at an earlier measuring time.
A particularity of this research is that the number of measuring times is not equal for
the portfolio companies (unbalanced design). The measuring times represent the
events of venture capital financing rounds, and the portfolio companies had had one,
two or three financing rounds when the questionnaires were completed. That means if
a company had not yet reached the second or third financing round, the data for that
and the following measuring times could not be collected. This required a statistical
technique that takes into account repeated measurements as well as unbalanced
designs.
For this research, the technique of mixed models from SPSS 13 was used because it
meets the demands of the research design. It offers a flexible modelling tool that can
adequately reproduce the given dependency structures. Therefore, that technique is
preferred over general linear models. In this case, it is not the typical mixed models
technique that is used because fixed and random effects are not used simultaneously.
All explanatory variables are assumed to be fixed effects.
Corresponding to the variables of the specific hypotheses, the explanatory elements

can be differentiated in covariates and factors. The factors include, for example, the
development stage and the region of the portfolio company. For the factors, it was
tested whether the response variable differed for categories of the factors and whether
differences between the reference category and the factor categories were significant.
For the covariates, such as size of the company, distance between the venture capitalist
and the portfolio company and corporate governance quality, it was tested whether
there was a linear relationship between the covariate and the response variable. For
example, the greater the venture capitalists’ influence, the better is the corporate
governance quality. Time was included in all models as a covariate in the form of the
financing round. This tested whether the response variable followed a linear trend over
time. Auto-correlations of the 1st order and heterogeneous variances were taken into
account. The model parameters were estimated with the REML (restricted maximum
likelihood) method.
143
The general equation of the mixed model is (as random effects were not taken into
account):
y XE H
or:
ª y1 º ª x11 x12 . . . x1 p º ª E1 º ª H 1 º
«y » «x x 22 . . . x 2 p »» « E 2 » «H 2 »
« 2» « 21 « » « »
« . » « . . . »« . » « . »
« » « »« » « »
« . » « . . . »« . » « . »
« . » « . . . »« . » « . »
« » « »« » « »
¬« y n ¼» ¬« x n1 xn 2 . . . x np ¼» ¬« E n ¼» ¬«H n ¼»
where y denotes the vector of observed yi's, X is the known matrix of xij's, ȕ is the
unknown fixed-effects parameter vector and İ is the unobserved vector of independent
and identically distributed Gaussian random errors.
The structure of variances is auto regressive (1st order) with heterogeneous variances.
The correlation between two elements is:
ȡ for adjacent elements,

2
ȡ for elements with a distance of 2,
ȡ3 for elements with a distance of 3,
ȡ4 for elements with a distance of 4,
and ȡ is between –1 and 1.
An example of the structure of variance for the case of 4 measuring times is:
V 12 V 2V 1 U V 3V 1 U 2 V 4V 1 U 3
V 2V 1 U V 22 V 3V 2 U V 4V 2 U 2
V 3V 1 U 2 V 3V 2 U V 32 V 4V 3 U
V 4V 1 U 3 V 4V 2 U 2 V 4V 3 U V 42
The results of the mixed models analyses include the coefficients and the confidence
levels for all explanatory variables as well as the lower and the upper level of the
coefficient. (The following discussion differentiates between the explanatory variable
that relates to the explanatory variable of the analysis and the control variables that are
explanatory variables for which the analysis is controlled.) Furthermore, the log likeli-
hood value and the R2 that indicate the quality of the model are given. In the next
sections, only the coefficient and confidence level for the explanatory variable that
144
relates to the hypothesis and R2 of the model are presented. The significance is
indicated by the following signs: "*" for the 90% confidence level, "**" for the 95%
confidence level and "***" for the 99% confidence level. In the case of covariates, the
coefficient x can be interpreted as follows: The value of the response variable
increases/decreases by x units if the explanatory variable increases by 1 unit. Similar-
ly, for the case of a factor as coefficient, the interpretation is: The value of the
response variable increases/decreases by x units in comparison to the reference
category of the factor variable.536
Four of the hypotheses included dichotomous response variables ("Yes" — 1 /"No" —

0 or "Variable Compensation or Equal" — 1/"Fix" — 0). These hypotheses could not
be tested with the mixed models technique because dichotomous response variables
cannot be used with this method. Therefore these hypotheses were tested using the
logistic regression technique. However, this technique does not take repeated measure-
ment into account, so it must be assumed that the observations at different measuring
times are independent.
The goal of the logistic regression is to predict the probability for which the response
variable has the value 1 under consideration of several influencing factors. Correspon-
dingly, influencing factors can increase or reduce this probability. The strength of this
influence is described by the odds ratio.
ª T ( x) º
log it >T ( x)@ log « » D E1 x1 E 2 x 2 ... E 2 x 2 E i xi
¬1 T ( x) ¼
The odds ratio indicates the effects of the explanatory variable on the response
variable. The odds ratio is the factor for which the probability of occurrence of the
response variable increases per unit of the explanatory variable.
For the odds ratio, 95% confidence intervals were used. A significant effect of the
influencing factor is only proven if the significance is equal to or less than 0,05. The
Nagelkerke’s R2 can be compared to the R2 of the linear regression and is between 0
and 1.
The results of the tests include the coefficients, values of significance, lower and upper
limits of the 95% confidence interval, and odds ratios of the explanatory variables, as
536
McCulloch/Searle (2000); Verbeke/Molenberghs (2000); Norusis (2006).
145
well as the log likelihood values and R2 of the models. In the tables of the next
sections, only the coefficients with indication of significance, odds ratios and the R2
values are given.537
For example, an odds ratio (one odd divided by second odd) of 1,5 can be interpreted
as follows: If the value of the influencing factors increases by one unit, then the
relationship between the probability of occurrence and the probability of non-
occurrence (odd) increases by the factor 1,5. If the influencing factor is an index
between 1 and 100 and the odd for an index value of 4 is 3,5, then the odd increases
for an index value of 4 to 5,25 (3,5*1,5). For factors, the increase is also related to the
reference category.
5.3.4 Representativeness
A test for goodness of fit was carried out to verify whether the results of the analysis
are representative for European venture capital-financed companies. This was done by
means of a chi-square test that tests whether the respondents correspond to the original
sample of the survey. If the null-hypothesis that the two groups are not significantly
different is supported, then it can be assumed that the group of respondents corres-
ponds to the sample.
Chi-square is calculated with the following formula
(O E ) 2
x2 ¦ E
where O is an observed frequency and E is an expected frequency asserted by the null-
hypothesis. The value of this equation can be compared to the chi-square distribution
to determine the goodness of fit.
For this research, the test was carried out for the regional and age distributions of the
portfolio companies. The required information was collected from the VentureXpert
database. Whereas the null-hypothesis was supported for the regional distribution,538
which means that the respondents correspond to the original sample, it was not
supported for the age distribution. It was found that there are relatively more respon-
dents in the younger age groups (up to five years and six to ten years) than in the
537
Kraft (1997), pp. 636 ff.; Hosmer/Lemeshow (1989); Norusis (2006).
146
original sample. This might be due to aged data in the VentureXpert database from
which the sample was derived, i.e., some of the older portfolio companies in the
sample might not be active at the time of the survey. This is confirmed by the high
number of invitations that could not be delivered to the addressees.539 Thus, mortality
of companies might lead to relatively few older companies in the group of respon-
dents. Nonetheless, this finding limits the representativeness of the results, and it must
be observed when interpreting them.
5.3.5 Basic Information on Respondents

In the following, basic information about the 139 respondents that completed the
questionnaire is presented. This allows better classification of the analysis with regard
to the characteristics of the portfolio companies that were included.
Number of financing rounds

The largest part of the portfolio companies had received only one financing round
from a venture capitalist (65 companies; 47%). Apart from that, 44 companies
(32%) had two financing rounds, and 30 companies (21%) had already completed 3
or more financing rounds when the questionnaire was completed. This is presented
in Figure 25.
75
Number of 65
respondents
50 44
30
25
0
1 2 3 or more
Figure 25: Respondents by number of financing rounds
This has consequences for the availability of data for the analysis because the
number of measuring times for a portfolio company depends on the number of
completed financing rounds. Information on the situation before and after the first
financing round could be collected for all 139 companies, whereas the information
for the situation after the second and third financing rounds could be collected for
538
Refer to Figure 23 for an overview of the regional distribution of the original sample and the group of
respondents.
539
For more information refer to 5.3.1.1.
147
only 74 and 30 companies, respectively. These numbers represent the maximum
number of cases that could be analysed for the four measuring times.
Development stage
The portfolio companies can be divided into five groups according to their
development stage. Figure 26 presents the development stages of the 139 portfolio
companies at the time of their first financing by a venture capitalist. Almost one
third of all companies were still in the seed phase; fewer companies were in the
start-up phase. With 50 companies, the biggest group was at that time in the expan-
sion phase. Altogether, 113 companies or 81% of all analysed portfolio companies
were early-stage investments whereas the other 26 companies or 19% were late
stage companies, primarily buyouts.
75
Number of
repondents 50
50 44
25
25 19
1
0
Seed Start-up Expansion Bridge MBO/MBI
Early stage Late stage

investments investments
Figure 26: Respondents by development stage540
540
148
Age
As noted before, there are more younger companies among the 139 respondents
than in the original sample. Still, the mean age is comparatively high with 15 years,
which is mainly due to some outliers (late stage investments). For the analysis,
three age-groups were created: portfolio companies that were at the time of the sur-
vey up to five years old, between six and ten years or eleven years or older. The
largest group with 50 companies (36%) is the first one, followed by the second one
with 47 companies (34%) and the third one with 42 companies (30%). Figure 27
shows the distribution of ages in an overview.
75
Number of
respondents
50
50 47
42
25
0
up to 5 years 6 to 10 years 11 or more years
Figure 27: Respondents by age group
Company size
Following the company classification from the European Union, the 139 portfolio
companies were grouped according to number of employees. Micro businesses
have up to nine employees; in the study 29 of these companies (21%) are analysed.
The largest group among the respondents is small companies with 10–49 employ-
ees (56 companies; 40%). Additionally, there are 34 medium companies (25%),
which have 50–249 employees, included in the survey. Finally, 20 large companies
(14%) with more than 250 employees completed the questionnaire. On average, the
companies have 208 employees. For a graphical presentation see Figure 28.
Number of 70
repondents60
56
50
40 34
29
30
20
20
10
0
1-9 em ployees: 10-49 em ployees: 50-249 em ployees: from 250
m icro business sm all com panies m edium com panies em ployees: large
com panies
Figure 28: Respondents by number of employees
149
Industries
Taking industry factors into account in the analysis requires the creation of groups
of industries with a sufficient number of portfolio companies. All respondents were
therefore grouped into eight industrial sectors as follows: hard- and software (23;
17%), medical and health (27; 19%), biotechnology (16; 12%), communication and
Internet (16; 12%), other business or consumer services (18; 13%), indus-
trials/energy (20; 14%), electronics and semiconductors (10; 7%) and other
industries (8; 6%). This distribution is shown in Figure 29.
Number of 75
repondents
50
23 27
16 18 20
25 17
10 8
0
Ha
Bi
Co
In
El
O
th
th
ed
du
ot
ec
rd
er
er
ec
ic
st
tro
./I
- /S
al
hn
Se
ria
nt
ni
of
/H
er
l/E
ol
cs
rv
tw
ea
og
ne
ice
ne
ar
lt h
rg
e
y
Figure 29: Respondents by industry
5.3.6 Basic Information on Invested Venture Capitalists

This paragraph describes the main characteristics of the lead venture capitalists that are
invested in the 139 analysed portfolio companies. These characteristics are used,
among others, to test the hypothesised relationships between the venture capitalists,
their influence and their impact on corporate governance.
Type of lead venture capital firm

The respondents were asked to provide information about their lead venture
capitalists for each financing round because it is expected that this is the most
influential investor. In the following figure, the lead venture capitalists are grouped
according to their type. The vast majority of lead investors are independent venture
capital firms (100 or 72% in the first financing round, 39 or 81% in the second
financing round and 24 or 86% in the third financing round). Venture capitalists
associated with a financial institution are the second most important group (23, 11
and 3 venture capitalists in the first, second and third financing round,
respectively). Corporate venture capitalists and governmental investors play a
relatively unimportant role as lead venture capitalists, as Figure 30 indicates.
150
Number of 140
respondents Other investors
120
100 Corporate venture
capitalists
80
Governm ental
60 investors
40 Financial institutions
20
Independent venture
0 capitalists
t=1 t=2 t=3
Figure 30: Venture capitalists by type
International scope of lead venture capital firm

The lead venture capitalists were also analysed in regard to the scope of their
international activity, i.e., in which geographic regions they invest. It was
distinguished between regional investments (i.e., in one region within a country),
investments with a national scope, investments in several European countries and
investments in Europe and beyond (global). Figure 31 shows that the largest group
of lead venture capitalists invests on a global level (in most cases in Europe and
North America, sometimes also additionally in Asia; 76, 43, 15 in the first, second
and third financing rounds, respectively). The second most-important group is
national investors, followed by venture capitalists that have a European scope.
Regional investors are of limited importance for the analysis, particularly in the
second and third financing rounds.
Number of 140
respondents 120 Regional
100
National
80
60
Europe
40
20 Global
0
t=1 t=2 t=3
Figure 31: Venture capitalists by international scope
Size of lead venture capital firm

The size of the invested venture capital firms was measured in terms of the number
of portfolio companies, which also indicates the investment experience of the
firms. The invested firms were divided in four groups: Firms with less than 20
151
portfolio companies are dominant with 53, 27 and 11 lead venture capitalists in the
first, second and third financing rounds, respectively. Investors with 20–99 port-
folio companies and those with 100–499 portfolio companies come thereafter. The
group of the biggest investors, those with more than 500 portfolio companies, are
still well represented with 16, 9 and 3 lead venture capital firms in the three
financing rounds. An overview of the distribution is given in Figure 32.
Number of 140
respondents 120 500 and m ore
portfolio com panies
100 100–499 portfolio
80 com panies
60 20–99 portfolio
40 com panies
20 Less than 20
portfolio com panies
0
t=1 t=2 t=3
Figure 32: Venture capitalists by number of portfolio companies
Contacts
The following figure shows the number of contacts per quarter between the
investment managers of the lead venture capitalists and the managers of the port-
folio companies. It indicates that they are regularly in contact, particularly after the
first and second financing rounds. In 58 (44%) and 29 (46%) of the portfolio
companies (after the first and second financing rounds, respectively), the managers
had ten or more contacts with the investment managers per quarter. In only one
exception in the second financing round did the investment manager have no
contact at all with the portfolio company.
Number of 140
respondents 120 10 and m ore
tim es
100 4–9 tim es
80
60 1–3 tim es
40
20 0 tim es
0
t=1 t=2 T03
Figure 33: Number of contacts between venture capitalists and portfolio companies
152
5.3.7 Perceived Relationship Between Venture Capital, Corporate
Governance and Firm Value
Before the detailed results of the analysis are presented in the next sections, the results
of three basic questions are described corresponding to the two research questions.
They refer to the respondents' assessment of the impact of venture capitalists on
corporate governance quality and of the latter on firm value.
With the first question, respondents assessed whether the impact of the venture
capitalist on the portfolio company's corporate governance was positive or negative.
59% of the respondents evaluated the impact as positive or very positive, whereas only
6% of the respondents assessed the impact as negative or very negative. The remaining
35% did not perceive a significantly positive or negative influence. The average
perceived impact was 3,7 on a scale from 1 ("– –") to 5 ("++").
The second and third questions dealt with the impact of good corporate governance on
firm value as measured by the company's performance as well as by its valuation.
Referring to the first relationship, 43% of the respondents perceived a positive or very
positive impact on performance, whereas 47% did not perceive any impact, and 10%
perceived the impact as negative or very negative. The average on the 5-step scale was
3,4, thus still positive. A similar impact was perceived in regard to the portfolio
company's valuation. 43% of the assessments were positive and only 8% of the
assessments were negative. Again, the group of respondents that perceives neither a
positive nor a negative influence of good corporate governance is the greatest with
49%. The average perceived impact is positive at 3,4. Figure 34 shows the results of
the three questions on the relationships between venture capital, corporate governance
and firm value in an overview.
Research Research
question 1 question 2
2
++
Perceived
impact
+1
o0
Impact of VC Impact of good Impact of good
involvement on corporate corporate
corporate governance on governance on
-
-1 governance quality performance valuation
--
-2
Figure 34: Mean respondents' perception of the impact of venture capitalists and good corporate
governance
153
These findings indicate the respondents' general perceptions. They can be compared
with the results from the detailed statistical analyses conducted to test the hypotheses
derived from theory. The corresponding results are presented in the next sections.
5.4 Reasons for Venture Capitalists' Influence on Corporate

Governance
5.4.1 Descriptive Results for Development of Reasons and
Influence
5.4.1.1 Risk Reduction
The first reason for the venture capitalists' influence that is analysed is the portfolio
companies' agency and business risk. The explanatory variables were collected for two
measuring times: for the time before the first financing round and for the current
situation at the time the respondent completed the questionnaire. The agency risk
index includes variables for the managerial ownership, the age of the portfolio compa-
nies, the specificity of the businesses, the importance of intangible assets, and the
degree of technology of the products. The mean of this index is 73% at both measuring
times. By contrast, the mean business risk grows over time from 64% to 69%. It relates
to variables for founder-CEOs, the start-up and functional experience of the top
management-teams, the number of products, the degree of the dynamics of industries,
and the attractiveness of markets. These two indexes are combined in the agency and
business risk index that increases from 68% before the first financing round to 71%
today. Figure 35 shows the development of the three indexes in an overview.
100%
Values of indexes
73% 73%
69% 71%
68%
64%
t=4
t=0
0%
Agency risk Business risk Agency and business

index index risk index
Figure 35: Development of agency and business risk over time
154
5.4.1.2 Value Creation
Value creation is the second reason derived from the theoretical analysis for venture
capitalists to influence corporate governance. The precedent corporate governance
quality is thereby expected to have a positive impact on the strength of the venture
capitalists' influence. Accordingly, corporate governance quality is used as an explana-
tory variable for testing the hypotheses. Corporate governance quality measured by
self-assessment of the respondents as well as by criteria increases over time. The mean
of the overall corporate governance quality index increases from 59% to 70% as
measured by self-assessment whereas the index derived from the criteria increases
from 54% to 78% in the same time. Detailed information on the development is intro-
duced in paragraph 5.5.1.
5.4.1.3 Exit Preparation

The third reason for increased influence of the venture capitalists on corporate gover-
nance is the preparation of an exit, in particular an IPO. Therefore, the respondents
were asked to indicate whether the portfolio companies planned to go public at the
measuring times. The proportion of companies that prepared a public exit remained
similar over the three measuring times. After the first financing round, 23 of 139 com-
panies (17%) planned an IPO; after the second financing round, 11 of 73 companies
(15%), and after the third financing round, five of 30 companies (17%). This indicates
that the number of cases for these tests of the associated hypotheses is relatively small.
The descriptive analysis of the variables related to venture capitalists' reasons for
influencing the corporate governance of portfolio companies is presented in an over-
view in Annex 6. The table includes the number of analysed cases ("N"), the minimum
and maximum observed values ("Min."/"Max"), the mean value ("Mean") and the
standard deviation ("Std. Dev.").
5.4.1.4 Strength of Influence

After the introduction of the explanatory variables of the hypotheses, the development
of the response variables is described. The venture capitalists' influence was assessed
by respondents on a scale ranging from "no influence" (1) to "very strong" influence
(4) for the different corporate governance elements. All elements were included in an
index of the strength of the overall venture capitalists’ influence. Over the three
measuring times, the index fluctuates around 2,7 on the four-step scale. T-tests were
155
carried out to analyse whether significant changes occurred between the time before
and after the first financing round as well as between the first and second financing
rounds. However, the differences of those means are not significant. Figure 36 shows
this development.
very strong
4
3
2,70 2,76 2,73
Strength of
VC's influence
no influence1
t=1 t=2 t=3
Figure 36: Development of overall venture capitalists' influence on corporate governance
This index can be broken down into the influence on the different corporate gover-
nance elements as Figure 37 shows, there are differences among these elements as well
as between measuring times. The strongest influence is exerted on the work of the
boards and the bonding and compensation of managers. For these elements, significant
increases were found by means of t-test analyses. Whereas the influence on the work
of the boards and the managers' compensation increases, particularly between the first
and the second financing rounds, the influence on the bonding of managers increases
in importance between the second and the third financing rounds. The weakest influ-
ence is exerted on the selection of managers.
4
very strong
*** Significant change at 1% level

**
3 **
** ** Significant change at 5% level
Strength of
VC's influence * Significant change at 10% level
2 t=3
t=2
t=1
no influence
1
As Se Bo Co Co Wo Re
se lec nd mp mp rk po
ss ing rt in
me tion of
en
sa
os
it io
of
Bo gD
nt of Ma tion no ard i sc
of Ma na
Ma na of f ipl
na ge ge
r Ma Boa ine
ge r s s na rd
rs ge
rs
Figure 37: Development of venture capitalists' influence on corporate governance elements

156
More detailed information on the variables related to the venture capitalists' influence
is introduced in a table in Annex 7.
5.4.2 Results for Hypotheses’ Tests

5.4.2.1 Risk Reduction
According to the first hypothesis, the portfolio companies' business and agency risk
determines the strength of the venture capitalists' influence: the higher the risk, the
stronger is the influence (H1.1). Because this hypothesis is derived from agency
theory, it relates in particular to the monitoring and bonding function of corporate
governance. Consequently, the influence on all corporate governance elements was
used as a response variable as well as the influence on only those elements that relate
to the monitoring or bonding function. The explanatory variable is the agency and
business risk index. In order to take into account other explanatory effects, the
analyses were controlled for the distance between the locations of the venture capi-
talists and the portfolio companies, the size and national location of the portfolio
company and the time (financing round). However, the R2 of these three analyses are
very low ranging from 0,012 to 0,035, which indicates that the model does not very
well explain the response variables. The coefficients for all three explanatory variables
are negative but not significantly so. That means that the findings rather contradict the
hypothesis but that no conclusion can be drawn because there is no significant result.
In a second step, the relationship between the agency and business risk and the
influence on individual corporate governance elements was analysed. The hypotheses
relate to the assessment (H1.1.1), selection (H1.1.2), compensation (H1.1.3) and
bonding (H1.1.4) of managers, the composition (H1.1.5) and work (H1.1.6) of the
board and the reporting discipline (H1.1.7). Again, the R2 of these analyses are very
low, and all the coefficients of the explanatory variables are negative against the
expectation. Only one of the tests delivered a significant result. It was found that
agency and business risk had a weakly negative impact on the venture capitalists'
influence on the composition of the board. The coefficient is low with 0,012 at the
90% confidence level, as Table 3 shows. This table, as well as the following tables,
includes the most important results from the statistical analyses that use the mixed
models technique. Every row represents one analysis for the testing of one hypothesis.
The given information includes the response, explanatory and control variables and the
coefficient for the impact of the explanatory variable and the R2 of the test. Moreover,
157
it is denoted whether the result for the explanatory variable is significant: "*" marks a
significant result at the 90% confidence level, "**" at the 95% confidence level and
"***" at the 99% confidence level. The presented findings indicate that the hypotheses
on the relationship between agency and business risk and the venture capitalists’ influ-
ence on corporate governance cannot be supported.
# Hypothesis Response variable Explanatory variable Coefficient Control variables R-square
H1.1 The greater the agency and Index of VC's influence Agency and business -0,088 lvcdist, cempngr, 0,012
business risks associated with an on all CG elements risk index finrou, landgr
investment, the greater is the
venture capitalists’ influence on
the corporate governance.
business risks associated with an on CG elements with risk index finrou, landgr
investment, the greater is the monitoring function
business risks associated with an on CG elements with risk index finrou, landgr
investment, the greater is the bonding function
H1.1.1 The greater the agency and VC's influence on Agency and business -0,001 lvcdist, cempngr, 0,054
business risks associated with an assessment of risk index finrou, landgr
investment, the greater is the managers
the assessment of the
managers.
H1.1.2 The greater the agency and VC's influence on Agency and business 0,004 lvcdist, cempngr, 0,017
business risks associated with an compensation of risk index finrou, landgr
the selection of the managers.
business risks associated with an compensation of risk index finrou, landgr
the compensation of the
managers.
business risks associated with an bonding of managers risk index finrou, landgr
the bonding of the portfolio
companies’ managers.
H1.1.5 The greater the agency and VC's influence on Agency and business -0,012* lvcdist, cempngr, 0,030
business risks associated with an composition of board risk index finrou, landgr
the composition of the board.
H1.1.6 The greater the agency and VC's influence on work Agency and business -0,004 lvcdist, cempngr, 0,052
business risks associated with an of board risk index finrou, landgr
venture capitalists' influence on
the work of the board.
H1.1.7 The greater the agency and VC's influence on Agency and business 0,002 lvcdist, cempngr, 0,042
business risks associated with an reporting discipline risk index finrou, landgr
the frequency of reporting.
Table 3: Statistical results for the hypotheses H1.1–H1.1.7
158
5.4.2.2 Value Creation
The hypothesis that the precedent corporate governance quality affects the venture
capitalists' impact on corporate governance (H1.2) is derived from the dynamic
resource-based view. Accordingly, the hypothesis was tested with venture capitalists'
influence on all elements as well as with their influence on the elements with an advice
function. Furthermore, the corporate governance quality used as an explanatory varia-
ble was measured by self-assessment (denoted in the table with "S") and criteria ("C").
In the mixed models analysis, several control variables were taken into account: the
distance between venture capitalists and portfolio companies, the size, development
stage and location of the portfolio companies and time. Nonetheless, the four analyses
did not deliver a significant result, and the R2 were again very low as Table 4 shows.
That means this basic hypothesis cannot be supported.
# Hypothesis Version Response variable Explanatory variable Coefficient Control variables R-square
H1.2 The better the initial corporate S Index of VC's influence CG quality index (self- 0,091 lvcdist, cempngr, 0,018
governance quality, the greater is on all CG elements assessment) finrou, cdev, landgr
the venture capitalists’ influence
on the corporate governance.
H1.2 The better the initial corporate C Index of VC's influence CG quality index 0,010 lvcdist, cempngr, 0,012
governance quality, the greater is on all CG elements (criteria) finrou, cdev, landgr
H1.2 The better the initial corporate S Index of VC's influence CG advice index (self- 0,080 lvcdist, cempngr, 0,015
governance quality, the greater is on CG elements with assessment) finrou, cdev, landgr
the venture capitalists’ influence advice function
H1.2 The better the initial corporate C Index of VC's influence CG advice index -0,043 lvcdist, cempngr, 0,018
governance quality, the greater is on CG elements with (criteria) finrou, cdev, landgr
the venture capitalists’ influence advice function
H1.2.1 The better the initial corporate S VC's influence on CG quality index (self- 0,000 lvcdist, cempngr, 0,025
governance quality, the greater is selection of new assessment) finrou, cdev, landgr
the venture capitalists’ influence managers
on the selection process of new
managers.
H1.2.1 The better the initial corporate C VC's influence on CG quality index 0,000 lvcdist, cempngr, 0,032
governance quality, the greater is selection of new (criteria) finrou, cdev, landgr
managers.
H1.2.1 The better the initial corporate S VC's influence on CG advice index (self- -0,005 lvcdist, cempngr, 0,039
governance quality, the greater is selection of new assessment) finrou, cdev, landgr
managers.
H1.2.1 The better the initial corporate C VC's influence on CG advice index 0,000 lvcdist, cempngr, 0,041
governance quality, the greater is selection of new (criteria) finrou, cdev, landgr
managers.
H1.2.1 The better the initial corporate S VC's influence on Efficiency of selection of -0,081 lvcdist, cempngr, 0,046
governance quality, the greater is selection of new new managers finrou, cdev, landgr
managers.
H1.2.1 The better the initial corporate C VC's influence on Index of quality of -0,005 lvcdist, cempngr, 0,142
governance quality, the greater is selection of new selection of managers finrou, cdev, landgr
managers.
Table 4: Statistical results for the hypotheses H1.2–H1.2.1

159
For a more detailed analysis, the hypotheses that relate to the individual corporate
governance elements with an advice function were tested. In particular, it was analysed
whether corporate governance quality — measured by both self-assessment and
criteria — affects the subsequent venture capitalist influence on the selection of
managers (1.2.1), the composition of the board (1.2.2) and the work of the board
(1.2.3). The resulting R2 of these analyses are slightly higher than in the first tests but
still comparatively low. All coefficients are also very low and fluctuate around zero.
Three of the analyses have significant results. The quality of the advice function and of
the board's composition — both measured by criteria — have a very weak negative
impact on the influence on this element. By contrast, the corporate governance advice
index measured by self-assessment has a weakly positive effect on the venture
capitalists' influence on the work of the board. However, because of the very low
coefficients, the explanatory power of these results is very limited. So these tests can
also shed no light on the venture capitalists' reasons for influencing portfolio compa-
nies' corporate governance.
160
H.1.2.2 The better the initial corporate S VC's influence on CG quality index (self- 0,000 lvcdist, cempngr, 0,005
governance quality, the greater is composition of board assessment) finrou, cdev, landgr
on the composition of the board.
H.1.2.2 The better the initial corporate C VC's influence on CG quality index -0,002 lvcdist, cempngr, 0,000
governance quality, the greater is composition of board (criteria) finrou, cdev, landgr
H.1.2.2 The better the initial corporate S VC's influence on CG advice index (self- 0,001 lvcdist, cempngr, 0,005
governance quality, the greater is composition of board assessment) finrou, cdev, landgr
H.1.2.2 The better the initial corporate C VC's influence on CG advice index -0,003* lvcdist, cempngr, 0,019
governance quality, the greater is composition of board (criteria) finrou, cdev, landgr
H.1.2.2 The better the initial corporate S VC's influence on Efficiency of composition 0,035 lvcdist, cempngr, 0,007
governance quality, the greater is composition of board of board: advice finrou, cdev, landgr
H.1.2.2 The better the initial corporate C VC's influence on Index of quality of board -0,003* lvcdist, cempngr, 0,002
governance quality, the greater is composition of board composition finrou, cdev, landgr
H1.2.3 The better the initial corporate S VC's influence on work CG quality index (self- 0,003 lvcdist, cempngr, 0,052
governance quality, the greater is of board assessment) finrou, cdev, landgr
on the work of the board.
H1.2.3 The better the initial corporate C VC's influence on work CG quality index 0,002 lvcdist, cempngr, 0,045
governance quality, the greater is of board (criteria) finrou, cdev, landgr
H1.2.3 The better the initial corporate S VC's influence on work CG advice index (self- 0,004* lvcdist, cempngr, 0,064
governance quality, the greater is of board assessment) finrou, cdev, landgr
H1.2.3 The better the initial corporate C VC's influence on work CG advice index 0,000 lvcdist, cempngr, 0,059
governance quality, the greater is of board (criteria) finrou, cdev, landgr
Table 5: Statistical results for the hypotheses H1.2.2–H1.2.3
5.4.2.3 Exit preparation

Hypothesis H1.3 says that venture capitalists' increase their influence before a poten-
tial public exit of portfolio companies. A mixed models analysis was carried out that
took the distance between the venture capitalists and the portfolio companies, the size,
development stage and location of the portfolio companies and the time into account
as control variables. The resulting coefficient of the impact was comparatively high
but not significant. Correspondingly, the R2 of the test is only 0,015. A more detailed
hypothesis predicts that more members are brought to the board that already have
experience as board members in listed companies (H1.3.2). In this case the R2 is
higher with 0,139 and the hypothesis is significantly supported. The coefficient of the
explanatory variable is 0,660 at the 99% confidence level as Table 6 indicates.
161
H1.3 Before a potential public exit, C Index of VC's influence Planned IPO 2,657 lvcdist, cempngr, 0,015
venture capitalists increase their on all CG elements finrou, cdev, landgr
influence on the corporate
governance of portfolio
companies.
H1.3.2 Before a potential public exit, it C Experience as managers Planned IPO 0,660*** lvcdist, cempngr, 0,139
is more probable that the or board member in finrou, cdev, landgr
portfolio companies have board listed companies of
members with experience in independent board
listed companies. members
Table 6: Statistical results for the hypotheses H1.3–1.3.2 (mixed models technique)
Similarly, support was found for hypothesis H1.3.1, which says that portfolio compa-
nies before a potential IPO more often comply with corporate governance codes than
do other portfolio companies. The analysis had a very high R2 of 0,570 and a very high
odds ratio of 160,567. That means that the probability that portfolio companies comply
with the corporate governance code is 160 times greater if an IPO is planned than if
one is not. Table 7 shows the result of the logistic regression used for this test because
the response variable is dummy coded.
H1.3.1 Before a potential publich exit it C Compliance with CG Planned IPO 5,078*** lvcdist, cempngr, 0,570
is more probable that the code finrou, cdev, landgr
portfolio company complies with
corporate governance codes.
Table 7: Statistical results for the hypothesis H1.3.1 (logistic regression technique)
5.4.2.4 Development of Reasons

According to the last hypothesis that relates to the reasons venture capitalists' influ-
ence the corporate governance of portfolio companies, the importance of the reasons
changes over time (H1.4). Whereas business and agency risks are expected to be more
important in the beginning, corporate governance quality is expected to become more
important later on. Correspondingly, the first test used only observations from the first
financing round into account, whereas the second test was done only with observations
from the second and third financing rounds. There was no change in the findings on
the impact of agency and business risks because this analysis did not deliver a signi-
ficant result. By contrast, the analysis on the influence of the precedent corporate
governance quality on venture capitalists' influence delivers support for the hypothesis.
The coefficient of the explanatory variable is 0,429 at the 99% confidence level. Table
8 indicates that value creation as a reason is supported by the analysis for later
162
financing rounds, which partly supports the hypothesis that the reasons of venture
capitalists change over time.
Control
# Hypothesis Version Response variable Explanatory variable Coefficient Odds-Ratio R-square
variables
H1.4 Agency and business risks have S Index of VC's influence Agency and business -0,104 160,567 lvcdist, 0,020
a stronger impact on venture on all CG elements risk index cempngr,
capitalists’ influence on the finrou,
corporate governance of portfolio landgr
companies at earlier financing
rounds than at later financing
rounds.
H1.4 Agency and business risks have S Index of VC's influence CG quality index (self- 0,429*** 160,567 lvcdist, 0,155
a stronger impact on venture on all CG elements assessment) cempngr,
capitalists’ influence on the finrou,
corporate governance of portfolio cdev,
companies at earlier financing landgr
rounds than at later financing
rounds.
Table 8: Statistical results for the hypothesis H1.4
# Hypothesis Support
H1.1 The greater the agency and business risks associated with an investment, the greater
is the venture capitalists’ influence on the corporate governance. ?
H1.1.1 The greater the agency and business risks associated with an investment, the greater
is the venture capitalists’ influence on the assessment of the managers.
?
is the venture capitalists’ influence on the selection of the managers. ?
is the venture capitalists’ influence on the compensation of the managers. ?
is the venture capitalists’ influence on the bonding of the portfolio companies’ ?
managers.
is the venture capitalists’ influence on the composition of the board.
?
is the venture capitalists' influence on the work of the board. ?
is the venture capitalists’ influence on the frequency of reporting. ?
H1.2 The better the initial corporate governance quality, the greater is the venture capitalists’
influence on the corporate governance. ?
H1.2.1 The better the initial corporate governance quality, the greater is the venture capitalists’
influence on the selection process of new managers. ?
influence on the composition of the board. ?
influence on the work of the board. ~
H1.3 Before a potential public exit, venture capitalists increase their influence on the
corporate governance of portfolio companies. ?
H1.3.1 Before a potential public exit it is more probable that the portfolio company complies
with corporate governance codes. 9
H1.3.2 Before a potential public exit, it is more probable that the portfolio companies have
board members with experience in listed companies. 9
H1.4 Agency and business risks have a stronger impact on venture capitalists’ influence on
the corporate governance of portfolio companies at earlier financing rounds than at later ~
financing rounds.
Figure 38: Overview of the results for hypotheses about the relationship between venture capitalists'
reasons and influence on corporate governance
163
In the above figure, the results of the tests that analysed the relationship between the
venture capitalists' reasons and their influence on the corporate governance of portfolio
companies are summarised. It indicates whether the hypotheses are largely supported
(9), the findings are mixed (~) or the test did not deliver a significant result (?). The
overview shows that the findings are unsatisfactory. Reasons for this outcome will be
discussed in section 6.2.
5.5 Effects of Venture Capitalists' Influence on Corporate

Governance
5.5.1 Descriptive Results for the Development of Corporate
Governance Quality
The corporate governance quality of the analysed portfolio companies significantly
increases over time, which is shown by both corporate governance measures.
Figure 39 shows that the mean of corporate governance quality measured by self-
assessment increased from 59% at the time before the first financing round to 70% at
the time after the third financing round. A particularly great increase takes place with
the first financing by a venture capitalist when the perceived corporate governance
quality increases by ten basis points. A t-test for paired samples delivered significant
differences between the means for t=0 and t=1 as well as between t=2 and t=3. How-
ever, the small decline between t=1 and t=2 is not significant because the null-
hypothesis of the t-test could not be rejected.
++1
quality – self-assessment(1)
+
0,75 ** 70%
***
69% 68%
59%
o
0,5
-
0,25 *** Significant change at 1% level
** Significant change at 5% level
* Significant change at 10% level

--0
t=0 t=1Averaget=2 t=3
Figure 39: Development of corporate governance quality — self-assessment
For corporate governance quality measured by criteria, an even stronger increase was
found. Over the three financing rounds, the mean index increased from 54% to 78%,
164
with a significant increase of 18 basis points at the time of the first venture capital
financing round.
100%
quality - criteria(1)
76% 78%
72%
*
**
54%

0%
t=0 t=1Averaget=2 t=3
Figure 40: Development of corporate governance quality — criteria
The comparison of the two measures reveals a difference in the development.

Although both indexes increase over time, the basis at the time before the first
financing round is relatively higher when the quality is measured by self-assessment
than when measured by criteria. However, at the following measuring times, the
quality measured by criteria is higher than that measured by self-assessment.
In the following, the development of the three corporate governance functions is

described. The monitoring function increases significantly after all three financing
rounds when the quality is measured by self-assessment of the respondents, but it
increases only after the first financing round when it is measured by criteria. The level
of quality was consistently assessed higher by the respondents than it was measured by
means of criteria. Figure 41 shows this comparison in an overview.
165
100%
Quality of corporate
governance Self-assessment Criteria
monitoring function
*** *** 70%
75% 69% 70%
*** 64%
61% 60%
58% *
**
50% 45%
25% *** Significant change at 1% level
0% * Significant change at 10% level
t=0 t=1 t=2 t=3 t=0 t=1 t=2 t=3
Figure 41: Development of the quality of the corporate governance monitoring function
In regard to the bonding function, the quality of corporate governance of the analysed
companies also increased. However, the increase as assessed by the respondents is
relatively limited (from 65% before the first financing round to 70% after the third
financing round). This is in contrast to a stronger increase of 14 basis points when the
quality is measured by criteria. For an overview, see Figure 42.
100%
bonding function
75% *** 71%
67%
70%
65% 65% 65% 65%
*
**
51%
50%
t=0 t=1 t=2 t=3 t=0 t=1 t=2 t=3
Figure 42: Development of the quality of the corporate governance bonding function
The quality of the advice function increases over the three financing rounds from 56%
to 68% when measured by self-assessment and from 44% to 79% when measured by
criteria. The second measurement is, with 35 basis points, the greatest increase of all
corporate governance functions. Particularly at the first financing round, there is a
significant improvement in the quality, as
Figure 43 shows.
166
100%
advice function 79%
75% 68%
66% 66% 66% 68%
***
*
**
58%
50% 44%
t=0 t=1 t=2 t=3 t=0 t=1 t=2 t=3
Figure 43: Development of the quality of the corporate governance advice function
In the following, the development of the individual elements is presented and

compared. Generally, for all corporate governance elements, a significant increase
with the first venture capital financing was found, but the level of the increase differs
for the elements and the two measures.
According to the perception of the respondents, the composition and work of the board
were the least efficient corporate governance elements before the first investment by a
venture capitalist. Correspondingly, these elements saw also the greatest increase over
time. The bonding of the managers was consistently assessed as the most adequate of
the corporate governance elements. Figure 44 shows all corporate governance ele-
ments in an overview.
++
5
Corporate governance *** Significant change at 1% level
quality –
**
***
+4
***
self-assessment Significant change at 5% level

**
***
***
***
***
***
**

o3 t=3
t=2
-2 t=1
t=0
--1
As S B C C C Wo Wo Re
se elec ond om om om rk rk po
ss p p p r
me tion ing o ens osit osit of B of B ting
nt of fM a i
tio on ion oa o D
of Ma a n n o of o f
rd: ard: isci
Ma n a B B M A p
na ager gers f Ma oar oar oni dvic line
ge s n ag d: M d: A ori t e
rs er o d ng
s nit v
or ice
ing
Figure 44: Development of the quality of corporate governance elements — self-assessment
167
Similarly, the composition and work of the board had the lowest level of fulfilment
when measured using the criteria. In addition to that, the criteria related to the compen-
sation of the managers were on average less fulfilled than those related to the other
corporate governance elements. The biggest increase was found for the composition of
the board, with 24 basis points. The development of all corporate governance elements
is presented in Figure 45.
100%
quality – criteria
***
75%
***
***
**
***
Significant change at 5% level
***
* **
50%
***
t=3
t=2
25%
t=1
t=0
0%
As Se Bo Co Co W Re
se le c nd m or po
ss in g pe m po ko rt i
m e ti on of
ns s it io f Bo ng
nt of a ti ar Di
of Ma Ma on no sc
Ma na na of fB d ip l
na ge ge M o a i ne
ge rs rs an rd
rs ag
er
s
Figure 45: Development of the quality of corporate governance elements — criteria
The development of the individual variables of corporate governance at the different

levels (overall corporate governance, corporate governance functions, corporate gover-
nance elements, and corporate governance criteria) over the four measuring imes is
presented in the table in Annex 8. It includes the number of portfolio companies that
were taken into account for the calculation of the value ("N"), the minimum and maxi-
mum values ("Min"/"Max") and the arithmetic mean ("Mean") and standard deviation
("Std. Dev.") of the variables. These variables are used as response variables in the
analyses to test the hypotheses on the relationship between the influence of venture
capitalists and the corporate governance of portfolio companies.
5.5.2 Results for Hypotheses’ Tests

After describing the development of corporate governance quality over the time of the
first three financing rounds, the results of the hypotheses' tests related to the relation-
ship between the venture capitalists' influence and the corporate governance quality of
portfolio companies are presented here. It should prove whether the increase in
corporate governance quality after the financing by venture capitalists found in the
168
descriptive analyses can be traced back to the venture capitalists' influence. The
analyses were primarily done using the mixed models technique, but for some hypo-
theses the logistic regression technique had to be used because of dichotomous
response variables.541
The basic hypothesis H2 predicts that the venture capitalists' influence has an impact
on the portfolio companies' corporate governance. It was tested with the two
measurements for corporate governance quality: self-assessment ("S") and criteria
("C"). Mixed models analyses were conducted that controlled for influences from the
venture capitalists' abilities, the size of the portfolio company, the measuring time, the
development stage and country of the portfolio company and the corporate governance
quality before the first financing round (t=0). Both hypotheses were supported at a
confidence level of 99% with coefficients of 0,129 for the analysis taking into account
the self-assessment measure and 0,194 for the measurement by criteria. The
coefficients of determination, R2, for the two tests are relatively high at 0,350 and
0,369. Table 9 shows the results in detail.
R-
# Hypothesis Version Response variable Explanatory variable Coefficient Control variables
square
H2 The venture capitalists' influence S CG quality index (self- Index of VC's influence 0,129*** lvcabi, cempngr, 0,350
has an impact on the portfolio assessment) on all CG elements finrou, cdev, landgr,
companies' corporate cgqind(t=0)
governance
H2 The venture capitalists' influence C CG quality index Index of VC's influence 0,194*** lvcabi, cempngr, 0,369
has an impact on the portfolio (criteria) on all CG elements finrou, cdev, landgr,
companies' corporate cgqinc(t=0)
governance
Table 9: Results for hypothesis H.2
After this general finding that venture capitalists' influence leads to an improvement of
the portfolio companies' corporate governance, it was determined which corporate
governance elements are affected by this influence. The results are presented for the
three elements related to the managers, the board and the reporting discipline, in that
order.
The following two tables present the results for the hypotheses on the relationship
between the venture capitalists' influence and the quality of the assessment and
selection of the managers. The tests indicate that the hypotheses are largely supported.
The venture capitalists' influence has a significantly positive effect on the assessment
and selection of the managers in the portfolio companies (H2.1). Similarly, the influ-
ence on the two underlying elements of the assessment of the managers (H2.1.2) and
541
For more information on the techniques, see 5.3.3.2.
169
the selection of the managers (H2.1.4) is also supported. The effect of the venture
capitalists' influence on the first element is, with a coefficient of 0,228, comparatively
stronger than the coefficient of the second element at 0,184. The R2 of the analysis of
H2.1.4 using the index of the quality of selection of managers as a response variable is
comparatively low at 0,150, but the coefficient for the explanatory variable is still
highly significant. In contrast to these findings, the hypothesis that tested the effect of
the venture capitalists' influence on the replacement of managers could not be signi-
ficantly supported. All analyses were controlled for the six variables introduced above.
Table 10 gives the details of these analyses, which used the mixed models technique.
R-
square
H2.1 The venture capitalists' influence S Efficiency of Assessment VC's influence on 0,171*** lvcabi, cempngr, 0,281
has an impact on the and Selection of assessment and finrou, cdev, landgr,
assessment and selection of Managers selection of managers maas(t=0)
managers.
H2.1.2 The stronger the venture S Efficiency of assessment VC's influence on 0,228*** lvcabi, cempngr, 0,379
capitalists’ influence, the more of managers assessment of finrou, cdev, landgr,
efficient is the assessment of the managers masse(t=0)
management.
H2.1.3 The stronger the venture C Replacements of VC's influence on 0,107 lvcabi, cempngr, 0,232
capitalists’ influence, the more managers per financing assessment of finrou, cdev, landgr,
likely managers are to be round managers mrepn(t=0)
replaced.
H2.1.4 The stronger the venture S Efficiency of selection of VC's influence on 0,184*** lvcabi, cempngr, 0,232
capitalists’ influence, the better is new managers selection of new finrou, cdev, landgr,
the managers' selection process. managers msele(t=0)
H2.1.4 The stronger the venture C Index of quality of VC's influence on 0,184*** lvcabi, cempngr, 0,150
capitalists’ influence, the better is selection of managers selection of new finrou, cdev, landgr,
the managers' selection process. managers mseind(t=0)
Table 10: Statistical results for hypotheses H2.1–H2.1.4 (mixed models)
One of the response variables was dichotomous, so a logistic regression analysis had to
be conducted. However, the analysis that tested whether assessment of the managers
becomes more likely with a stronger influence by the lead venture capitalist was signi-
ficantly supported as well (Table 11). The probability that the managers are assessed is
18 times higher for every unit that the venture capitalists' influence increases.
R-
square
H2.1.1 The stronger the venture C Conduct of assessment VC's influence on 1,085*** lvcabi, cempngr, 0,454
capitalists’ influence is, the more of managers assessment of finrou, cdev, landgr,
likely is the assessment of the managers massn(t=0)
managers.
Table 11: Statistical results for hypotheses H2.1.1 (logistic regression)
Next, it was analysed whether the venture capitalists' influence affected the quality of
the portfolio companies' bonding measures for the managers (H2.2). The results were
mixed; the two different measures of corporate governance quality used as response
variables led to different results. Whereas the use of the self-assessment measure
delivered a highly significant coefficient of 0,198, the analysis using the measurement
170
by criteria delivered a high but not significant coefficient of 1,825. This is reflected in
an R2 of 0,347 for the first analysis and 0,261 for the second.
R-
square
H2.2 Venture capitalists' influence has S Efficiency of bonding of VC's influence on 0,198*** lvcabi, cempngr, 0,374
a positive impact on the bonding managers bonding of managers finrou, cdev, landgr,
of managers. mbone(t=0)
H2.2 Venture capitalists' influence has Q Index of quality of VC's influence on 1,825 lvcabi, cempngr, 0,261
a positive impact on the bonding bonding of managers bonding of managers finrou, cdev, landgr,
of managers. mboind(t=0)
Table 12: Statistical results for the hypothesis H2.2
The impact of the venture capitalists' influence on the third corporate governance
element was tested in a next step. The results indicate that the influence has a
significantly positive impact on the adequacy of the managers' compensation (H2.3).
The coefficient that relates to the measurement by criteria is very high at 2,935
(R2=0,565) and compares to 0,162 (R2=0,596) when the corporate governance quality
is measured by self-assessment. In contrast to this, no significant support was found
for hypothesis H2.3.3, which expected an impact on the level of cash compensation of
the managers. Table 13 presents the detailed results.
R-
square
H2.3 The venture capitalists' influence S Efficiency of VC's influence on 0,162*** lvcabi, cempngr, 0,596
has an impact on the compensation of compensation of finrou, cdev, landgr,
compensation of managers. managers managers mcome(t=0)
H2.3 The venture capitalists' influence C Index of quality of VC's influence on 2,935** lvcabi, cempngr, 0,565
has an impact on the compensation of compensation of finrou, cdev, landgr,
compensation of managers. managers managers mbvin(t=0)
H2.3.3 The stronger the venture C Level of compensation VC's influence on -0,021 lvcabi, cempngr, 0,507
capitalists’ influence is the lower compared to industry compensation of finrou, cdev, landgr,
is the cash compensation of the managers mcomco(t=0)
managers.
Table 13: Statistical results for hypotheses H2.3–H2.3.3 (mixed models)
Two analyses with dichotomous explanatory variables were tested using a logistic
regression. Corresponding to the finding on cash compensation, the venture capitalists'
influence seems not to have a significant impact on the level of variable compensation.
However, the odds ratio is relatively high at 169,647. On the other hand, a relatively
high and significant coefficient was found for the use of variable compensation linked
to mid- and long-term goals (H2.3.2), as Table 14 shows. For this analysis, the odds
ratio is even higher. The use of these compensation elements is 2.414 times more
probable for every unit (on a four unit scale) that venture capitalist influence increases.
171
R-
square
H2.3.1 The stronger the venture C Importance of annual VC's influence on -0,01 lvcabi, cempngr, 0,691
capitalists’ influence, the higher bonus versus variable compensation of finrou, cdev, landgr,
is the proportion of the variable compensation linked to managers mcomim(t=0)
compensation. mid-/long-term
development
H2.3.2 The stronger the venture C Managers with variable VC's influence on 1,395*** lvcabi, cempngr, 0,708
capitalists influence the more compensation linked to compensation of finrou, cdev, landgr,
likely is the use of variable mid-/long-term managers mcomve(t=0)
compensation parts that are development
linked to mid- and long-term
goals.
Table 14: Statistical results for hypotheses H2.3.1–H2.3.2 (logistic regression)
The descriptive results indicated that the quality of the composition and work of the
board increased strongly at the time of venture capital investments. Table 15 includes
the results for the statistical analyses related to the composition of the board. First, the
basic hypothesis of whether venture capitalists' influence has a positive impact on the
composition was tested, again using the different measures for corporate governance
quality (H2.4). Although there was no significant relationship found for the strength of
the influence and the efficiency of board composition as perceived by the respondents,
a highly significant and strongly positive impact was found for the quality index
measured by criteria. These differences resulted although both analyses were equally
controlled for the lead-venture capitalists' abilities, the portfolio companies' size,
development stage, location and previous corporate governance quality as well as for
time effects (financing round). The venture capitalists' influence as an explanatory
variable for the index of the quality of board composition has a coefficient of 5,868 at
a confidence level of 99%. The R2 of this analysis is 0,223. Corresponding to the detai-
led hypotheses, this relationship was broken down into criteria for the independence
and the qualification of the board members. Against the expectations, the analysis did
not support an increase in the independence of boards with venture capitalists'
influence (H2.4.1). By contrast, the qualifications of the board members measured in
the form of experiences in different areas improved with a stronger venture capitalist
influence (H2.4.2). This was found for four out of the six analysed kinds of
experiences. Using similar control variables as before, the hypotheses related to the
industry experience, international experience, functional experience and experience as
a board member in listed companies were supported. The strongest impact was found
for functional experience with a coefficient of 0,431. In regard to the board members'
executive and start-up experience, the analysis delivered positive but not significant
results.
172
R-
square
H2.4 The venture capitalists' influence S Efficiency of composition VC's influence on 0,043 lvcabi, cempngr, 0,444
has an impact on the of board: monitoring composition of board finrou, cdev, landgr,
composition of the board. bsome(t=0)
H2.4 The venture capitalists' influence S Efficiency of composition VC's influence on 0,084 lvcabi, cempngr, 0,239
has an impact on the of board: advice composition of board finrou, cdev, landgr,
composition of the board. bsoae(t=0)
H2.4 The venture capitalists' influence C Index of quality of board VC's influence on 5,868*** lvcabi, cempngr, 0,223
has an impact on the composition composition of board finrou, cdev, landgr,
composition of the board. bsiind(t=0)
H2.4.1 The stronger the venture C Proportion of VC's influence on 0,014 lvcabi, cempngr, 0,038
capitalists’ influence is, the independent board composition of board finrou, cdev, landgr,
greater is the proportion of members bspin(t=0)
independent members in the
board.
H2.4.2 The stronger the venture C Industry experience of VC's influence on 0,235** lvcabi, cempngr, 0,409
capitalists’ influence, the stronger independent board composition of board finrou, cdev, landgr,
are the experiences of the board. members bsoiex(t=0)
H2.4.2 The stronger the venture C Executive experience of VC's influence on 0,172 lvcabi, cempngr, 0,284
are the experiences of the board. members bsoeex(t=0)
H2.4.2 The stronger the venture C International experience VC's influence on 0,299** lvcabi, cempngr, 0,399
capitalists’ influence, the stronger of independent board composition of board finrou, cdev, landgr,
are the experiences of the board. members bsotex(t=0)
H2.4.2 The stronger the venture C Functional experience of VC's influence on 0,431*** lvcabi, cempngr, 0,160
are the experiences of the board. members bsofex(t=0)
H2.4.2 The stronger the venture C Startup experience of VC's influence on 0,135 lvcabi, cempngr, 0,221
are the experiences of the board. members bsosex(t=0)
H2.4.2 The stronger the venture C Experience as managers VC's influence on 0,183* lvcabi, cempngr, 0,173
capitalists’ influence, the stronger or board member in composition of board finrou, cdev, landgr,
are the experiences of the board. listed companies of bsolex(t=0)
independent board
members
Table 15: Statistical results for hypotheses H2.4–H2.4.2
After the analyses related to the composition of the board, the impact of the venture
capitalists on the work of the board was analysed (H2.5). First, the self-assessment
measures are described. The impact of the venture capitalists' influence on the self-
assessed efficiency of the work of the board is significantly positive in regard to the
monitoring function of the board but not in regard to the advice function. For the
impact on the response variable efficiency of the work of the board, the coefficient for
monitoring is 0,203 at a confidence level of 99% controlling for the introduced control
variables above. Then the measurement by criteria was used for the analyses. The
result was relatively high and positive but not significant, despite an R2 of 0,279. But
more detailed tests delivered significant relationships for specific criteria. The venture
capitalists' influence leads to significantly more frequent (H2.5.1) and better prepared
(H2.5.2) board meetings. The third expected relationship was not supported: There is a
negative but not significant result for the impact on the involvement of boards in
strategic decision making (H2.5.3). These findings are summarised in Table 16.
173
R-
square
H2.5 The venture capitalists' influence S Efficiency of work of VC's influence on work 0,203*** lvcabi, cempngr, 0,251
has an impact on the work of the board: monitoring of board finrou, cdev, landgr,
board. bwome(t=0)
H2.5 The venture capitalists' influence S Efficiency of work of VC's influence on work 0,045 lvcabi, cempngr, 0,219
has an impact on the work of the board: advice of board finrou, cdev, landgr,
board. bwoae(t=0)
H2.5 The venture capitalists' influence C Index of quality of work VC's influence on work 1,273 lvcabi, cempngr, 0,279
has an impact on the work of the of board of board finrou, cdev, landgr,
board. bwoind(t=0)
H2.5.1 The stronger the venture C Number of board VC's influence on work 0,610** lvcabi, cempngr, 0,203
capitalists’ influence, the more meetings per year of board finrou, cdev, landgr,
frequently board meetings take bwomn(t=0)
place.
H2.5.2 The stronger the venture C Distribution of agenda VC's influence on work 0,117** lvcabi, cempngr, 0,403
capitalists’ influence, the better and relevant information of board finrou, cdev, landgr,
prepared board meetings are. bwoin(t=0)
H2.5.3 The stronger the venture C Proportion of time VC's influence on work -0,91 lvcabi, cempngr, 0,198
capitalists’ influence, the better devoted to strategic of board finrou, cdev, landgr,
prepared board meetings are. issues bwost(t=0)
Table 16: Statistical results for hypotheses H2.5–2.5.3
The last group of hypotheses is related to the relationship between the venture
capitalists' influence and the reporting discipline of the portfolio companies. The two
corporate governance measures consistently support a positive impact (H2.6). The
coefficient of the explanatory variables is, at 2,269, much stronger for the index of the
corresponding criteria than for the self-assessment by the respondents (0,108). The
more detailed analyses found that the venture capitalists' influence significantly increa-
ses the frequency (H2.6.1) and the timeliness (2.6.2) of the portfolio companies'
reporting. By contrast, it does not have a significant influence on the comprehensive-
ness of the information provided (H2.6.3) or on the extent of target-actual differences
(2.6.4). As Table 17 shows, all tests have been controlled for the lead venture capi-
talists' abilities, the portfolio companies' size, development stage, and location, as well
as the financing round and the original quality of the corporate governance element.
R-
square
H2.6 The venture capitalists' influence S Efficiency of reporting VC's influence on 0,108** lvcabi, cempngr, 0,247
has a positive impact on discipline reporting discipline finrou, cdev, landgr,
reporting discipline. rmone(t=0)
H2.6 The venture capitalists' influence C Index of quality of VC's influence on 2,269** lvcabi, cempngr, 0,398
has a positive impact on reporting discipline reporting discipline finrou, cdev, landgr,
reporting discipline. rind(t=0)
H2.6.1 The stronger the venture C Number of reports per VC's influence on 0,783*** lvcabi, cempngr, 0,436
capitalists’ influence, the more year reporting discipline finrou, cdev, landgr,
frequent is the portfolio rrn(t=0)
H2.6.2 The stronger the venture C Timeliness of reporting VC's influence on 0,154*** lvcabi, cempngr, 0,458
capitalists’ influence, the more reporting discipline finrou, cdev, landgr,
timely is the portfolio company’s ront(t=0)
reporting.
H2.6.3 The stronger the venture C Completeness of VC's influence on 1,668 lvcabi, cempngr, 0,281
capitalists’ influence, the more reporting reporting discipline finrou, cdev, landgr,
comprehensive is the portfolio rcompr(t=0)
H2.6.4 The stronger the venture C Extent of target-actual VC's influence on 0,064 lvcabi, cempngr, 0,298
capitalists’ influence, the more differences reporting discipline finrou, cdev, landgr,
accurate is the portfolio rdiff(t=0)
Table 17: Statistical results for hypotheses H2.6–2.6.4
174
The presentation of these results indicates that the basic hypothesis that venture
capitalists' influence leads to better corporate governance is supported. Although this
holds also for a large part of the more detailed hypotheses related to individual
corporate governance elements, there are also some expected relationships that could
not be significantly supported. For an overview, Figure 46 indicates whether the
hypotheses are largely supported (9),the findings are mixed (~) or the test did not
deliver a significant result (?).
H2 The venture capitalists' influence has an impact on the portfolio companies' corporate
governance 9
H2.1 The venture capitalists' influence has a positive impact on the assessment and
selection of managers. 9
H2.1.1 The stronger the venture capitalists’ influence is the more likely is the assessment of
the managers. 9
H2.1.2 The stronger the venture capitalists’ influence, the more efficient is the assessment of
the management. 9
H2.1.3 The stronger the venture capitalists’ influence, the more likely managers are to be
replaced.
?
H2.1.4 The stronger the venture capitalists’ influence, the better is the managers' selection
process. 9
H2.2 Venture capitalists' influence has a positive impact on the bonding of managers. ~
H2.3 The venture capitalists' influence has a positive impact on the compensation of
managers. 9
H2.3.1 The stronger the venture capitalists’ influence, the higher is the proportion of the
variable compensation. ?
H2.3.2 The stronger the venture capitalists' influence, the more likely is the use of variable
compensation parts linked to mid- and long-term goals. 9
H2.3.3 The stronger the venture capitalists’ influence is the lower is the cash compensation of
the managers. ?
H2.4 The venture capitalists' influence has an impact on the composition of the board. ~
H2.4.1 The stronger the venture capitalists’ influence is the greater is the proportion of
independent members in the board. ?
H2.4.2 The stronger the venture capitalists’ influence, the stronger are the experiences of the
board.
~
H2.5 The venture capitalists' influence has a positive impact on the work of the board. ~
H2.5.1 The stronger the venture capitalists’ influence, the more frequently board meetings take
place.
9
H2.5.2 The stronger the venture capitalists’ influence, the better prepared board meetings are. 9
H2.5.3 The stronger the venture capitalists’ influence is the more involved is the board in
strategic decision making. ?
H2.6 The venture capitalists' influence has a positive impact on reporting discipline. 9
H2.6.1 The stronger the venture capitalists’ influence, the more frequent is the portfolio
company’s reporting. 9
H2.6.2 The stronger the venture capitalists’ influence, the more timely is the portfolio
company’s reporting. 9
H2.6.3 The stronger the venture capitalists’ influence, the more comprehensive is the portfolio
company’s reporting. ?
H2.6.4 The stronger the venture capitalists’ influence, the more accurate is the portfolio
company’s reporting. ?
Figure 46: Overview of the results for hypotheses about the relationship between the venture capitalists'
influence and corporate governance quality
175
5.6 Abilities of Venture Capitalists' to Influence Corporate
Governance
5.6.1 Descriptive Results for Venture Capitalists' Abilities
The lead venture capitalists' abilities to influence corporate governance considered in
the research are their control rights, the characteristics of venture capital firms and the
characteristics of the investment managers associated with an individual portfolio
company. Moreover, the trustfulness of the relationship between the lead venture
capitalists' investment managers and the managers of the portfolio company is also
taken into account. The lead venture capitalists in many portfolio companies changed
over time so the variables measuring the abilities cannot be seen as a development but
rather as three snapshots. Furthermore, it must be taken into consideration that the
group of portfolio companies whose answers are included declines over the three
measuring times, so that the number of companies that provided information for the
time after the third financing round is small.
On the highest level, the mean index of the lead venture capitalists' abilities includes
the level of control rights and the characteristics of the venture capital firms and the
investment managers. The average of this index fluctuates between 58% and 62%, as
Figure 47 shows. T-tests did not deliver any significant differences between these
values.
100%
Value of Index
75%
61% 62% 58%
50%
25%
0%
Ind
ex
t=1 t=2 of
A t=3
bil
it ie
s
Figure 47: Index of venture capitalists abilities' over time
The fulfilment of the three underlying subindexes is presented in Figure 48. The
average control rights index that relates to the ownership and board membership rights
of the lead venture capitalists decreases from 62% to 45%, though there were no signi-
ficant changes found for the values at the three measuring times. The average of the
176
index of characteristics of the lead venture capital firms remains equal around 54%. It
takes the reputation and the experience of the venture capitalists into account. The
mean of the characteristics of the investment managers grows insignificantly from
69% to 73% and concerns the experiences and commitment of the investment
managers.
100
Values of indexes
in %
73 74
69
62
56 54 54
53
45
t=3
t=2
t=1
0
Control rights Characteristics of Characteristics of
index lead-VC index investment manager
index
Figure 48: Subindexes of venture capitalists' abilities over time
Apart from these abilities, trust between the venture capitalists and the portfolio
companies is expected to influence corporate governance quality. In the analysed
portfolio companies, the level of trust is relatively high with an average between 4,4
and 4,8 on a scale of 1 to 5. The increase after the third financing round might be due
to the fact that only in successful investments are venture capitalists willing to provide
capital for a third time. The means for the three measuring times are presented in
Figure 49.
++
5 4,8
4,4 4,4
Strength of trust
+4
o3
-
2
--1
t=1 t=2 t=3
Figure 49: Trust between investment managers and portfolio companies' managers over time
177
Information on all variables related to the venture capitalists' abilities is introduced in
the table in Annex 9.
5.6.2 Results for Hypotheses' Tests

After the description of the abilities of the lead venture capitalists, multivariate tests
were done to find out whether the abilities have a significant influence on the
corporate governance quality of the portfolio companies. This basic hypothesis was
analysed again for the two measures of corporate governance quality: the indexes for
self-assessment and corporate governance criteria (H3). Both tests were controlled for
the strength of the venture capitalists' influence, the trust between the venture capita-
lists and the portfolio companies, the size, development stage and location of the
portfolio companies, the financing round, and the corporate governance quality before
the first financing round. The resulting R2 are relatively high at 0,424 and 0,369. The
coefficients of the explanatory variables are 0,067 for the self-assessment measure and
0,219 for the measurement by criteria, as Table 18 shows. That means that the basic
hypothesis related to the abilities is supported. In the following, the impact of the indi-
vidual elements of this index are analysed using the more detailed hypotheses, in
particular the control rights of the lead venture capitalists and the characteristics of the
venture capital firms and the investment managers.
H3 The abilities of venture capital S CG quality index (self- Index of abilities 0,067* vciind, imtrus, 0,424
firms have impact on the assessment) cempngr, finrou,
corporate governance of portfolio cdev, landgr,
compaies cgqind(t=0)
H3 The abilities of venture capital C CG quality index Index of abilities 0,219*** vciind, imtrus, 0,369
firms have impact on the (criteria) cempngr, finrou,
corporate governance of portfolio cdev, landgr,
compaies cgqinc(t=0)
Table 18: Statistical results for hypothesis H3
First, it was analysed whether there is a significant relationship between the lead
venture capitalists’ control rights and corporate governance quality (H3.1) at different
levels: for the overall corporate governance index, the index for the monitoring
function and the index for the bonding function. Furthermore, these response variables
were analysed again for the two measures. As an explanatory variable, the control
rights index was used along with the variables that relate to the lead venture
capitalists’ ownership rights and board seats. All tests were controlled for the variables
introduced before. Although the R2 of the models was relatively high, ranging from
0,269 to 0,506, only one of the tests delivered a significant result. The control rights
178
were found to have a significantly positive impact on corporate governance quality
measured by criteria, with a coefficient of 0,101. This indicates that there is only weak
support for the hypothesis that the venture capitalists’ control rights significantly affect
the corporate governance quality of portfolio companies.
H3.1 The control rights of venture S CG quality index (self- Control rights of lead-VC- -0,003 vciind, imtrus, 0,433
capital firms have effects on their assessment) F index cempngr, finrou,
impact on the corporate cdev, landgr,
governance of portfolio cgqind(t=0)
companies.
H3.1 The control rights of venture C CG quality index Control rights of lead-VC- 0,101** vciind, imtrus, 0,357
capital firms have effects on their (criteria) F index cempngr, finrou,
governance of portfolio cgqinc(t=0)
companies.
H3.1 The control rights of venture S CG monitoring index Control rights of lead-VC- 0,028 vciind, imtrus, 0,389
capital firms have effects on their (self-assessment) F index cempngr, finrou,
governance of portfolio cgmind(t=0)
companies.
H3.1 The control rights of venture C CG monitoring index Control rights of lead-VC- 0,037 vciind, imtrus, 0,269
governance of portfolio cgmcin(t=0)
companies.
H3.1 The control rights of venture S CG bonding index (self- Control rights of lead-VC- -0,044 vciind, imtrus, 0,506
capital firms have effects on their assessment) F index cempngr, finrou,
governance of portfolio cgbind(t=0)
companies.
H3.1 The control rights of venture C CG bonding index Control rights of lead-VC- -0,012 vciind, imtrus, 0,436
governance of portfolio cgbcin(t=0)
companies.
H3.1.1 The stronger the venture S CG quality index (self- Ownership rights of lead- -0,016 vciind, imtrus, 0,486
capitalist’s control rights are, the assessment) VC cempngr, finrou,
stronger is the impact of its cdev, landgr,
influence on the corporate cgqind(t=0)
companies.
H3.1.1 The stronger the venture C CG quality index Ownership rights of lead- 0,023 vciind, imtrus, 0,333
capitalists' control right rights, — (criteria) VC cempngr, finrou,
in terms of ownership rights and cdev, landgr,
board seats — the stronger is cgqinc(t=0)
their influence on the corporate
companies.
H3.1.1 The stronger the venture S CG quality index (self- Board seat lead-VC -0,528 vciind, imtrus, 0,432
capitalists' control right rights, — assessment) cempngr, finrou,
board seats — the stronger is cgqind(t=0)
companies.
H3.1.1 The stronger the venture C CG quality index Board seat lead-VC 6,673* vciind, imtrus, 0,352
capitalists' control right rights, — (criteria) cempngr, finrou,
board seats — the stronger is cgqinc(t=0)
companies.
H3.1.2 The stronger the venture S CG monitoring index Ownership rights of lead- 0,010 vciind, imtrus, 0,464
capitalists' control rights, the (self-assessment) VC cempngr, finrou,
greater is the impact of their cdev, landgr,
influence on the elements related cgmind(t=0)
to the monitoring function of
H3.1.2 The stronger the venture C CG monitoring index Ownership rights of lead- 0,008 vciind, imtrus, 0,315
capitalists' control rights, the (criteria) VC cempngr, finrou,
influence on the elements related cgmcin(t=0)
H3.1.2 The stronger the venture S CG monitoring index Board seat lead-VC 0,974 vciind, imtrus, 0,381
capitalists' control rights, the (self-assessment) cempngr, finrou,
influence on the elements related cgmind(t=0)
H3.1.2 The stronger the venture C CG monitoring index Board seat lead-VC 2,604 vciind, imtrus, 0,266
capitalists' control rights, the (criteria) cempngr, finrou,
influence on the elements related cgmcin(t=0)
179
H3.1.3 The stronger the venture S CG bonding index (self- Ownership rights of lead- -0,026 vciind, imtrus, 0,609
capitalists' control rights, the assessment) VC cempngr, finrou,
influence on the elements related cgbind(t=0)
to the bonding function of
H3.1.3 The stronger the venture C CG bonding index Ownership rights of lead- -0,04 vciind, imtrus, 0,500
capitalists' control rights, the (criteria) VC cempngr, finrou,
influence on the elements related cgbcin(t=0)
H3.1.3 The stronger the venture S CG bonding index (self- Board seat lead-VC -3,455 vciind, imtrus, 0,528
capitalists' control rights, the assessment) cempngr, finrou,
influence on the elements related cgbind(t=0)
H3.1.3 The stronger the venture C CG bonding index Board seat lead-VC -0,027 vciind, imtrus, 0,428
capitalists' control rights, the (criteria) cempngr, finrou,
influence on the elements related cgbcin(t=0)
Next, it is analysed whether the characteristics of the lead venture capital firms
influence the corporate governance of portfolio companies. The basic hypothesis
(H3.2) was tested for overall corporate governance quality as well as for the index of
the corporate governance advice function. Although no significant relationship was
found for the corporate governance index, there was support for the latter response
variable. Controlling for the different above mentioned variables, the corresponding
coefficients are 0,089 for the self-assessment measurement and 0,115 for the measure-
ment by criteria. The R2 of the two models are 0,355 and 0,209, respectively. Hypothe-
sis H2.2.1 relates to the expectation that independent venture capitalists have a greater
impact on the corporate governance of portfolio companies than other types of venture
capitalists. Similarly, it was supported only for the advice function of corporate gover-
nance. Although the coefficients are very high, 4,362 for the advice index measured by
self-assessment and 5,442 for the advice index measured by criteria, only the first
result was significant. This corresponds to a much higher R2 of the first analysis,
0,344, compared with 0,191 for the latter. These findings are presented in Table 20.
180
H3.2 The characteristics of venture S CG quality index (self- Characteristics of lead- 0,033 vciind, imtrus, 0,430
capital firms have effects on their assessment) VC-F index cempngr, finrou,
companies.
H3.2 The characteristics of venture C CG quality index Characteristics of lead- 0,011 vciind, imtrus, 0,349
capital firms have effects on their (criteria) VC-F index cempngr, finrou,
companies.
H3.2 The characteristics of venture S CG advice index (self- Characteristics of lead- 0,089** vciind, imtrus, 0,355
capital firms have effects on their assessment) VC-F index cempngr, finrou,
governance of portfolio cgaind(t=0)
companies.
H3.2 The characteristics of venture C CG advice index Characteristics of lead- 0,115* vciind, imtrus, 0,209
capital firms have effects on their (criteria) VC-F index cempngr, finrou,
governance of portfolio cgacin(t=0)
companies.
H3.2.1 Independent venture capital S CG quality index (self- Independent lead-VC-F 1,275 vciind, imtrus, 0,423
firms’ influence has a greater assessment) cempngr, finrou,
companies than that of corporate
venture capitalists and bank-
related and governmental
H3.2.1 Independent venture capital C CG quality index Independent lead-VC-F -5,643 vciind, imtrus, 0,372
firms’ influence has a greater (criteria) cempngr, finrou,
H3.2.1 Independent venture capital S CG advice index (self- Independent lead-VC-F 4,362* vciind, imtrus, 0,344
firms’ influence has a greater assessment) cempngr, finrou,
H3.2.1 Independent venture capital C CG advice index Independent lead-VC-F 5,332 vciind, imtrus, 0,191
firms’ influence has a greater (criteria) cempngr, finrou,
The following table describes the results for the analyses related to the hypothesis that
stronger investment experience of the lead venture capital firm has a positive impact
on the corporate governance quality of portfolio companies. For the explanatory var-
iable, three measures were used: the number of portfolio companies, the invested
capital and the age of the venture capitalists. Nevertheless, there is no significant
result, although all coefficients of the explanatory variables are positive and the R2 of
the models are relatively high, ranging between 0,188 and 0,448.
181
H3.2.2 The more investment experience S CG quality index (self- Number of portfolio 0,002 vciind, imtrus, 0,453
a venture capital firm has, the assessment) companies lead-VC-F cempngr, finrou,
greater are the effects of its cdev, landgr,
companies.
H3.2.2 The more investment experience C CG quality index Number of portfolio 0,002 vciind, imtrus, 0,353
a venture capital firm has, the (criteria) companies lead-VC-F cempngr, finrou,
influence on the corporate cgqinc(t=0)
companies.
H3.2.2 The more investment experience S CG advice index (self- Number of portfolio 0,003 vciind, imtrus, 0,371
a venture capital firm has, the assessment) companies lead-VC-F cempngr, finrou,
influence on the corporate cgaind(t=0)
companies.
H3.2.2 The more investment experience C CG advice index Number of portfolio 0,004 vciind, imtrus, 0,185
a venture capital firm has, the (criteria) companies lead-VC-F cempngr, finrou,
influence on the corporate cgacin(t=0)
companies.
H3.2.2 The more investment experience S CG quality index (self- Invested capital VC-F 0,000 vciind, imtrus, 0,448
a venture capital firm has, the assessment) cempngr, finrou,
companies.
H3.2.2 The more investment experience C CG quality index Invested capital VC-F 0,001 vciind, imtrus, 0,352
a venture capital firm has, the (criteria) cempngr, finrou,
companies.
H3.2.2 The more investment experience S CG advice index (self- Invested capital VC-F 0,001 vciind, imtrus, 0,367
companies.
H3.2.2 The more investment experience C CG advice index Invested capital VC-F 0,001 vciind, imtrus, 0,188
companies.
H3.2.2 The more investment experience S CG quality index (self- Age of VC-F 0,423 vciind, imtrus, 0,439
companies.
H3.2.2 The more investment experience C CG quality index Age of VC-F 3,452 vciind, imtrus, 0,360
companies.
H3.2.2 The more investment experience S CG advice index (self- Age of VC-F 2,438 vciind, imtrus, 0,351
companies.
H3.2.2 The more investment experience C CG advice index Age of VC-F 2,582 vciind, imtrus, 0,190
companies.
Table 21: Statistical results for hypothesis H3.2.2
Two other characteristics analysed are the international experience (H3.2.3; values
given for the impact of global investors: lvcint=3) and the reputation (H3.2.4) of the
venture capitalists. Despite relatively high R2 values and the use of four response
variables for each explanatory variable, there were no significant results. Reputation
led to comparatively high coefficients, particularly in regard to the corporate
182
governance’s advice function, but none of these coefficients is significant. Hence, the
analysis did not support these hypotheses. Table 22 shows the results in an overview.
H3.2.3 The greater the international S CG quality index (self- International activity of -1,09 vciind, imtrus, 0,429
experience of the venture capital assessment) VC-F: region cempngr, finrou,
firms, the greater are the effects cdev, landgr,
of their influence on the cgqind(t=0)
corporate governance of portfolio
companies.
H3.2.3 The greater the international C CG quality index International activity of -6,18 vciind, imtrus, 0,356
experience of the venture capital (criteria) VC-F: region cempngr, finrou,
of their influence on the cgqinc(t=0)
companies.
H3.2.3 The greater the international S CG advice index (self- International activity of -2,29 vciind, imtrus, 0,347
experience of the venture capital assessment) VC-F: region cempngr, finrou,
of their influence on the cgaind(t=0)
companies.
H3.2.3 The greater the international C CG advice index International activity of 4,001 vciind, imtrus, 0,198
experience of the venture capital (criteria) VC-F: region cempngr, finrou,
of their influence on the cgacin(t=0)
companies.
H3.2.4 The greater the reputation of a S CG quality index (self- Reputation of VC-F 2,101 vciind, imtrus, 0,437
venture capital firm, the greater assessment) cempngr, finrou,
are the effects of its influence on cdev, landgr,
the corporate governance of cgqind(t=0)
H3.2.4 The greater the reputation of a C CG quality index Reputation of VC-F 1,831 vciind, imtrus, 0,352
venture capital firm, the greater (criteria) cempngr, finrou,
the corporate governance of cgqinc(t=0)
H3.2.4 The greater the reputation of a S CG advice index (self- Reputation of VC-F 3,429 vciind, imtrus, 0,351
venture capital firm, the greater assessment) cempngr, finrou,
the corporate governance of cgaind(t=0)
H3.2.4 The greater the reputation of a C CG advice index Reputation of VC-F 2,074 vciind, imtrus, 0,188
venture capital firm, the greater (criteria) cempngr, finrou,
the corporate governance of cgacin(t=0)
Table 22: Statistical results for hypotheses H3.2.3–H3.2.4
The third element of the analysed abilities refers to the characteristics of the
investment managers of the lead venture capitalists. Corresponding to hypothesis
H3.3, it is predicted that these characteristics have an impact on the corporate
governance of the portfolio companies. The analyses were done using the mixed
models technique and were controlled for the lead venture capitalists’ influence, the
trust between them and the managers of the portfolio companies, as well as the size,
development stage, and location of the portfolio companies; the time; and the original
corporate governance quality at t=0. Corresponding to the above hypotheses' tests, four
response variables were used: the overall corporate governance quality as well as the
quality of the advice function, measured by self-assessment and by criteria. The hypo-
thesis is supported by all four analyses, but the strength of the impact differs. The
impact on the self-assessed corporate governance measures is much lower than for the
183
measure related to criteria. Moreover, the impact is greater on the advice function than
on the overall corporate governance quality.
H3.3 The characteristics of investment S CG quality index (self- Abilities of VC-IM index 0,054** vciind, imtrus, 0,432
managers have effects on their assessment) cempngr, finrou,
companies.
H3.3 The characteristics of investment C CG quality index Abilities of VC-IM index 0,197*** vciind, imtrus, 0,373
managers have effects on their (criteria) cempngr, finrou,
companies.
H3.3 The characteristics of investment S CG advice index (self- Abilities of VC-IM index 0,075* vciind, imtrus, 0,358
managers have effects on their assessment) cempngr, finrou,
companies.
H3.3 The characteristics of investment C CG advice index Abilities of VC-IM index 0,258*** vciind, imtrus, 0,229
managers have effects on their (criteria) cempngr, finrou,
companies.
Table 23: Statistical results for hypothesis H3.3
In the following, the impact of the individual characteristics of the investment

managers is analysed in detail. To begin with, their experience in the venture capital
industry is taken as an explanatory variable for the response variables of overall
corporate governance quality and quality of the advice function, measured by self-
assessment and by criteria (H3.3.1). The four tests deliver very positive results, of
which three are also significant. Venture capital experience has a coefficient of 6,581
at the 90% confidence level when explaining the overall corporate governance quality
index measured by criteria and 9,217 at the 95% confidence level when explaining the
quality of the advice function. The R2 are 0,379 and 0,206, respectively. Using the
self-assessment measure, only the test with the advice index as a response variable was
significant, with a coefficient of 3,600 at the 90% confidence level and an R2 of 0,352.
There is less significant support for the hypothesis that more experience in the
portfolio companies’ industries has a positive impact on corporate governance quality
(H3.3.2). On the other hand, the mixed models analysis delivered a highly significant
and very positive impact for the investment managers’ industry experience on the
overall corporate governance quality, with a coefficient of 8,151. By contrast, the other
three results were not significant despite relatively high R2 values between 0,192 and
0,418, as Table 24 indicates.
184
H3.3.1 The greater the investment S CG quality index (self- Experience in VC 2,119 vciind, imtrus, 0,400
manager’s experience in the assessment) industry VC-IM cempngr, finrou,
venture capital industry, the cdev, landgr,
greater is the impact of his/her cgqind(t=0)
companies.
H3.3.1 The greater the investment C CG quality index Experience in VC 6,561* vciind, imtrus, 0,379
manager’s experience in the (criteria) industry VC-IM cempngr, finrou,
greater is the impact of his/her cgqinc(t=0)
companies.
H3.3.1 The greater the investment S CG advice index (self- Experience in VC 3,600* vciind, imtrus, 0,352
manager’s experience in the assessment) industry VC-IM cempngr, finrou,
greater is the impact of his/her cgaind(t=0)
companies.
H3.3.1 The greater the investment C CG advice index Experience in VC 9,217** vciind, imtrus, 0,206
manager’s experience in the (criteria) industry VC-IM cempngr, finrou,
greater is the impact of his/her cgacin(t=0)
companies.
H3.3.2 The greater the investment S CG quality index (self- Industry experience VC- 0,227 vciind, imtrus, 0,418
managers' experience in the assessment) IM cempngr, finrou,
portfolio company’s industry, the cdev, landgr,
greater is the impact of their cgqind(t=0)
companies.
H3.3.2 The greater the investment C CG quality index Industry experience VC- 8,151*** vciind, imtrus, 0,362
managers' experience in the (criteria) IM cempngr, finrou,
greater is the impact of their cgqinc(t=0)
companies.
H3.3.2 The greater the investment S CG advice index (self- Industry experience VC- 1,272 vciind, imtrus, 0,341
managers' experience in the assessment) IM cempngr, finrou,
greater is the impact of their cgaind(t=0)
companies.
H3.3.2 The greater the investment C CG advice index Industry experience VC- 3,916 vciind, imtrus, 0,192
managers' experience in the (criteria) IM cempngr, finrou,
greater is the impact of their cgacin(t=0)
companies.
Similarly, significant support for a positive impact of the investment managers'

international experience was found in only one of the four analyses (H3.3.3). Although
all analyses resulted in high coefficients between 2,159 and 4,985, only the impact on
corporate governance quality measured by self-assessment was significant. For the
confidence level of 95%, the coefficient of the explanatory variable is 3,296 when the
above introduced control variables are taken into account. The R2 is relatively high at
0,401. Apart from that, the start-up experience of the investment managers was also in
one case a significant explanatory variable of corporate governance quality. If the
185
quality of the advice function measured by criteria is used as a response variable, then
the coefficient is 9,269 at the confidence level of 95%. The R2 of this model is 0,187.
H3.3.3 The greater the investment S CG quality index (self- International experience 3,296** vciind, imtrus, 0,401
managers' international assessment) VC-IM cempngr, finrou,
experience in the venture capital cdev, landgr,
industry, the greater is the impact cgqind(t=0)
of their influence on the
companies.
H3.3.3 The greater the investment C CG quality index International experience 3,365 vciind, imtrus, 0,372
managers' international (criteria) VC-IM cempngr, finrou,
industry, the greater is the impact cgqinc(t=0)
companies.
H3.3.3 The greater the investment S CG advice index (self- International experience 2,159 vciind, imtrus, 0,302
managers' international assessment) VC-IM cempngr, finrou,
industry, the greater is the impact cgaind(t=0)
companies.
H3.3.3 The greater the investment C CG advice index International experience 4,985 vciind, imtrus, 0,167
managers' international (criteria) VC-IM cempngr, finrou,
industry, the greater is the impact cgacin(t=0)
companies.
H3.3.4 The greater the investment S CG quality index (self- Startup experience VC- 1,457 vciind, imtrus, 0,392
manager’s start-up experience is, assessment) IM cempngr, finrou,
the greater is the impact of cdev, landgr,
his/her influence on the cgqind(t=0)
companies
H3.3.4 The greater the investment C CG quality index Startup experience VC- 2,699 vciind, imtrus, 0,384
manager’s start-up experience is, (criteria) IM cempngr, finrou,
the greater is the impact of cdev, landgr,
his/her influence on the cgqinc(t=0)
companies
H3.3.4 The greater the investment S CG advice index (self- Startup experience VC- 2,673 vciind, imtrus, 0,319
managers' start-up experience, assessment) IM cempngr, finrou,
the greater is the impact of their cdev, landgr,
companies.
H3.3.4 The greater the investment C CG advice index Startup experience VC- 9,269** vciind, imtrus, 0,187
managers' start-up experience, (criteria) IM cempngr, finrou,
the greater is the impact of their cdev, landgr,
companies.
The last trait of the investment managers analysed is their commitment to the portfolio
companies. Again, tests were carried out for the two corporate governance measures at
the highest level as well as for the advice function. In contrast to the expectations,
hypothesis H3.3.5 is not supported by the tests. The coefficients for all explanatory
variables are relatively low and not significant even though the R2 values are relatively
high for three of the analyses. Table 26 shows the results in an overview.
186
H3.3.5 The greater the commitment of S CG quality index (self- Number of contacts per 0,009 vciind, imtrus, 0,433
the investment managers, the assessment) quarter VC-IM cempngr, finrou,
companies.
H3.3.5 The greater the commitment of C CG quality index Number of contacts per 0,015 vciind, imtrus, 0,343
the investment managers, the (criteria) quarter VC-IM cempngr, finrou,
companies.
H3.3.5 The greater the commitment of S CG advice index (self- Number of contacts per 0,045 vciind, imtrus, 0,344
the investment managers, the assessment) quarter VC-IM cempngr, finrou,
companies.
H3.3.5 The greater the commitment of C CG advice index Number of contacts per 0,131 vciind, imtrus, 0,187
the investment managers, the (criteria) quarter VC-IM cempngr, finrou,
companies.
Table 26: Statistical results for hypothesis H3.3.5
Finally, the trust between the lead venture capitalists' investment managers and the
portfolio companies' managers is also expected to affect corporate governance quality
(H3.4). Corresponding to the analysis above, it was tested with four different response
variables: the two measures for overall corporate governance quality and the quality of
the corporate governance's advice function. The tests were controlled for the strength
of the venture capitalists' influence and the portfolio companies' size, development
stage, location, and financing round as well as the original corporate governance
quality before the first financing round. Significant results were found only for the two
tests using self-assessment measures. The coefficient of the impact of the trustfulness
of the relationship is relatively high at 4,405 for the overall corporate governance
quality and at 6,883 for the advice function. The R2 values are also comparatively high
at 0,428 and 0,340. The two analyses using measures by criteria also delivered positive
coefficients, but they were not significant. There might be a relationship between the
perception of the respondents and the trust of the investment managers. Table 27
presents the results for this hypothesis.
This concludes the detailed results for the hypotheses related to the venture capitalists'
abilities to influence the corporate governance of their portfolio companies. Figure 50
indicates whether the hypotheses are supported or not.
187
H3.4 The impact of the venture S CG quality index (self- Trustfullness of 4,405*** vciind, cempngr, 0,428
capitalists influence is greater if assessment) relationship VC-M finrou, cdev, landgr,
their relationship with the cgqind(t=0)
managers of portfolio companies
is trustful.
H3.4 The impact of the venture C CG quality index Trustfullness of 0,830 vciind, cempngr, 0,348
capitalists influence is greater if (criteria) relationship VC-M finrou, cdev, landgr,
their relationship with the cgqinc(t=0)
is trustful.
H3.4 The impact of the venture S CG advice index (self- Trustfullness of 6,883*** vciind, cempngr, 0,340
capitalists influence is greater if assessment) relationship VC-M finrou, cdev, landgr,
their relationship with the cgaind(t=0)
is trustful.
H3.4 The impact of the venture C CG advice index Trustfullness of 1,672 vciind, cempngr, 0,181
capitalists influence is greater if (criteria) relationship VC-M finrou, cdev, landgr,
their relationship with the cgacin(t=0)
is trustful.
Table 27: Statistical results for hypothesis H3.4
H3 The abilities of venture capitalists have an impact on the corporate governance of

portfolio compaies 9
H3.1 The control rights of venture capital firms have a positive impact on the corporate
governance of portfolio companies. ~
H3.1.1 The stronger the venture capitalists' control right rights, — in terms of ownership rights
and board seats — the stronger is their influence on the corporate governance of ~
influence on the elements related to the monitoring function of corporate governance. ?
influence on the elements related to the bonding function of corporate governance. ~
H3.2 The characteristics of venture capital firms have positive impact on the corporate
governance of portfolio companies. ~
H3.2.1 Independent venture capital firms’ influence has a greater impact on the corporate
governance of portfolio companies than that of corporate venture capitalists and bank- ~
related and governmental venture capitalists.
H3.2.2 The more investment experience a venture capital firm has, the greater are the effects
of its influence on the corporate governance of portfolio companies. ?
H3.2.3 The greater the international experience of the venture capital firms, the greater are the
effects of their influence on the corporate governance of portfolio companies. ?
H3.2.4 The greater the reputation of a venture capital firm, the greater are the effects of its
influence on the corporate governance of portfolio companies. ?
H3.3 The characteristics of investment managers have positive impact on the corporate
governance of portfolio companies. 9
H3.3.1 The greater the investment managers' experience in the portfolio company’s industry,
the greater is the impact of their influence on the corporate governance of portfolio ~
companies.
H3.3.2 The greater the investment manager’s experience in the portfolio company’s industry is
the greater is the impact of his/her influence on the corporate governance of portfolio ~
companies.
H3.3.3 The greater the investment managers' international experience in the venture capital
industry, the greater is the impact of their influence on the corporate governance of ~
H3.3.4 The greater the investment managers' start-up experience, the greater is the impact of
their influence on the corporate governance of portfolio companies. ~
H3.3.5 The greater the commitment of the investment managers, the greater is the impact of
their influence on the corporate governance of portfolio companies. ?
H3.4 The impact of the venture capitalists influence is greater if their relationship with the
managers of portfolio companies is trustful. ~
Figure 50: Overview of the results for hypotheses about the relationship between venture capitalists'
abilities and corporate governance quality
188
5.7 Effects of Corporate Governance on Firm Value
5.7.1 Descriptive Results for Development of Firm Value
In this section, the development of the portfolio companies’ firm value is described.
The firm value was analysed with two general perspectives: firm performance and firm
valuation. Besides this, the variables for firm value include self-assessment measures
and measures in the form of criteria.
To start with, the relative performance of the companies was assessed by the
respondents. They evaluated how competitive their companies were and how well they
performed compared to their own business plans. Although the means of both
measures were on the positive side of the scale, an increase was found only for compe-
titiveness. It significantly grew at the time of the first and second financing rounds, as
Figure 51 shows.
++
5
+4 *** Relative competiveness
***
o3
Relative performance
(compared to plan)
-2 *** Significant change at 1% level

--1
t=0 t=1 t=2 t=3
Figure 51: Development of portfolio companies’ competitiveness
Next, the performance was measured by criteria for profitability and the growth of the
companies. The collected performance measures are EBITDA margin, net profit
margin, return on equity and return on assets. The means of the first three measures
develop similarly over the course of the four measuring times: they decline over time
and become negative for the last measuring time. A particularly strong decline was
found for the return on equity with a reduction from 15% to –4,6%. As this develop-
ment might not have been expected, it should be noted that the mean for the time after
the second and third financing rounds could possibly be biased by the small number of
respondents. In contrast to the three other measures, return on assets does not steadily
decline. The mean fluctuates between 5,5% and 10,3%. The reasons for the different
189
development of this measure are unclear. Either the companies are highly financed by
debt, which is improbable, or the differences are caused by the fact that the companies
that responded to the relevant questions differ. Figure 52 shows the developments in
an overview.
Mean EBITDA-margin Mean net-profit-margin

20% 20%
10% 7,6% 7,4% 10%

3,2% 4,9% 4,6%
1,8%
0% 0%
t=0 t=1 t=2 t=3 t=0 t=1 t=2 t=3
-4,3% -5,3%
-10% -10%
Mean return on equity Mean return on assets

20% 20%
15,0%
11,7% 10,3%
10% 10% 8,3%
7,1% 7,0%
5,5%
0% 0%
t=0 t=1 t=2 t=3 t=0 t=1 t=2 t=3
-4,6%
-10% -10%
Figure 52: Development of portfolio companies’ profitability measures
The growth rates of the analysed portfolio companies increase with venture capital
financing but decline afterwards, as expected. The growth rate in terms of employees
precedes the growth of sales and cashflows. The means of the growth rates are
relatively high, ranging from 17% for the cashflows before the first financing round to
94% for employees after the first financing round. The high values can be explained
by basis effects because growth companies before the first financing round are compa-
ratively small. A significant development was found for the changes in the growth rate
of employees between the first three measuring times and for the change in the growth
rate of cashflows between the first two measuring times, as Figure 53 indicates.
190
in % 100
90 **
80 Employees Sales
70
**
60 Cashflows
50
40
***
30
20
10
0
t=0 t=1 t=2 t=3
Figure 53: Development of portfolio companies’ growth rates
The second perspective of the firm value is the valuation of the portfolio companies.
First, the respondents provided a self-assessment of the development of their
companies’ valuations. Between the first and the second financing rounds, the mean
valuation improved whereas between the second and the third financing rounds, the
valuation remained almost constant. A t-test demonstrated that this development is
significant at the 99% level, as Figure 54 shows.
++
++
2
2
++
1
1
******
oo
0
0
t=1
t=1 vs.
vs. t=2
t=2 t=2
t=2 vs.
vs. t=3
t=3
***
*** Significant
Significant change
change at
at 1%
1% level
level
--
-1
-1
**
** Significant
Significant change
change at
at 5%
5% level
level
-- ** Significant
Significant change
change at
at 10%
10% level
level
--
-2
-2
Figure 54: Development of portfolio companies’ valuation
The more detailed analyses using changes of sales and EBITDA multiples as measures
provide a similar picture. Between the first and second financing rounds, both
measures increase, by 89,3% and 18,8% respectively, whereas between the second and
third financing rounds the growth declines to 28,8% for the mean sales multiple and
even turns to a reduction of 4,3% for the mean EBITDA multiple. However, t-tests did
not deliver a significant change between the two measuring times. The changes of the
two variables are presented in Figure 55.
191
Sales multiple EBITDA multiple
100% 100%
83%
75% 75%
50% 50%
29%
25% 25% 20%
0% 0%
t=1 vs. t=2 t=2 vs. t=3 t=1 vs. t=2 t=2 vs. t=3 -4%
-25% -25%
Figure 55: Development of portfolio companies’ multiples
Annex 10 gives detailed information related to all measures of firm value. It includes
the minimum and maximum values, the mean and standard deviation as well as the
number of observations.
5.7.2 Results for Hypotheses' Tests

After describing the development of firm value, this section presents the results of the
tests of the hypotheses that relate to the relationship between the corporate governance
quality and firm value. Corresponding to the structure of the last section, the hypo-
theses that refer to the portfolio companies’ performance will be analysed first, and the
hypotheses that refer to their valuation will be described second. Because the effects of
good corporate governance might be observable only after a lag, the relationship is
tested not only with the explanatory and response variables from the same period
(labelled “same period” in the table) but also with the explanatory variable from one
period and the response variable from the subsequent period (“next period”).
The self-assessed relative performance measures were used first to the test the impact
of good corporate governance on the performance of the portfolio companies (H4.1).
All analyses that relate competitiveness with the corporate governance quality of the
same period delivered positive results. Both analyses that use the competitiveness of
the portfolio companies as a response variable and the corporate governance quality
with the two different measures (self-assessment and criteria) support the hypothesis.
However, the two resulting coefficients are relatively low, with 0,012 for the self-
assessment measure and 0,003 for the measurement by criteria. This is supported by
the results of the tests that use performance relative to the companies’ business plans
as a response variable; again the strength of the impact is very low (0,023 and 0,004).
Furthermore, the resulting R2 values are relatively low for three of the four tests using
the mixed models technique. The results for the impact of corporate governance on the
performance of the subsequent period contrast those findings. Although only two tests
192
were significant, they predict a weak but negative impact of good corporate gover-
nance on performance. Again, the R2 values of the analyses were relatively low. Thus
the results show that the hypothesis is weakly supported if the immediate impact of
good corporate governance is analysed, but it is contradicted if the impact on future
performance is analysed. Table 28 shows these findings.
H4.1 The corporate governance S - same Competitiveness relative CG quality index (self- 0,012*** pcindust, cempngr, 0,150
quality of company has effects on period to direct and indirect assessment) finrou, cdev, landgr
its fundamental performance. competitors
H4.1 The corporate governance S - same Competitiveness relative CG quality index 0,003** pcindust, cempngr, 0,114
quality of company has effects on period to direct and indirect (criteria) finrou, cdev, landgr
H4.1 The corporate governance S - next Competitiveness relative CG quality index (self- -0,011*** pcindust, cempngr, 0,109
quality of company has effects on period to direct and indirect assessment) finrou, cdev, landgr
H4.1 The corporate governance S - next Competitiveness relative CG quality index -0,003 pcindust, cempngr, 0,091
quality of company has effects on period to direct and indirect (criteria) finrou, cdev, landgr
H4.1 The corporate governance S - same Performance according CG quality index (self- 0,023*** pcindust, cempngr, 0,212
quality of company has effects on period to plan assessment) finrou, cdev, landgr
its fundamental performance.
H4.1 The corporate governance S - same Performance according CG quality index 0,004* pcindust, cempngr, 0,115
quality of company has effects on period to plan (criteria) finrou, cdev, landgr
H4.1 The corporate governance S - next Performance according CG quality index (self- -0,024*** pcindust, cempngr, 0,207
quality of company has effects on period to plan assessment) finrou, cdev, landgr
H4.1 The corporate governance S - next Performance according CG quality index -0,001 pcindust, cempngr, 0,119
quality of company has effects on period to plan (criteria) finrou, cdev, landgr
Table 28: Statistical results for hypothesis 4.1
These findings can be compared to the more detailed analyses using measures for the
profitability and growth of the portfolio companies. In regard to the profitability mea-
sures, significant results were found for the net profit margin and the return on equity
as well as the return on assets but not for the EBITDA margin. The test relating self-
assessed corporate governance quality to the net profit margin of the same period
delivers support for the hypothesis with a coefficient for the explanatory variable of
0,155 at the 95% confidence level. However, it must be noted that the R2 of this
analysis is only 0,017. Besides this, the two corporate governance quality measures
significantly affect the return on equity of the subsequent period. Here, the influence is
much stronger with coefficients of 0,264 and 0,218, and the R2 values for these ana-
lyses are also comparably high at 0,376 and 0,439. This can, therefore, be seen as
stronger support for the hypothesis. By contrast, the results of the tests relating to
return on assets are mixed. Although there is support for a positive relationship
between corporate governance measured by self-assessment and return on assets of the
same period, the other three tests deliver negative but not significant coefficients.
193
Although the coefficient of the first analysis is comparably strong at 0,233, the expla-
natory value is limited by a low R2 of only 0,013. As Table 29 indicates, the relation-
ship between good corporate governance and profitability can only be supported for
some measures. Additionally, differences in the impact might occur at different
measuring times.
The better the corporate

governance quality of a company S - same CG quality index (self- pcindust, cempngr,
H4.1.1 is, the higher is its profitability. period EBITDA-margin assessment) 0,136 finrou, cdev, landgr 0,028

governance quality of a company C - same CG quality index pcindust, cempngr,
H4.1.1 is, the higher is its profitability. period EBITDA-margin (criteria) 0,020 finrou, cdev, landgr 0,028

governance quality of a company S - next CG quality index (self- pcindust, cempngr,
H4.1.1 is, the higher is its profitability. period EBITDA-margin assessment) 0,224 finrou, cdev, landgr 0,090

governance quality of a company C - next CG quality index pcindust, cempngr,
H4.1.1 is, the higher is its profitability. period EBITDA-margin (criteria) 0,036 finrou, cdev, landgr 0,091

H4.1.1 is, the higher is its profitability. period Net-profit-margin assessment) 0,155** finrou, cdev, landgr 0,017

H4.1.1 is, the higher is its profitability. period Net-profit-margin (criteria) 0,029 finrou, cdev, landgr 0,028

H4.1.1 is, the higher is its profitability. period Net-profit-margin assessment) 0,057 finrou, cdev, landgr 0,089

H4.1.1 is, the higher is its profitability. period Net-profit-margin (criteria) -0,04 finrou, cdev, landgr 0,097

H4.1.1 is, the higher is its profitability. period Return-on-equity assessment) 0,221 finrou, cdev, landgr 0,035

H4.1.1 is, the higher is its profitability. period Net-profit-margin (criteria) 0,083 finrou, cdev, landgr 0,043

H4.1.1 is, the higher is its profitability. period Return-on-equity assessment) 0,264* finrou, cdev, landgr 0,376

H4.1.1 is, the higher is its profitability. period Return-on-equity (criteria) 0,218** finrou, cdev, landgr 0,439

H4.1.1 is, the higher is its profitability. period Return-on-assets assessment) 0,233** finrou, cdev, landgr 0,013

H4.1.1 is, the higher is its profitability. period Return-on-assets (criteria) -0,004 finrou, cdev, landgr 0,009

H4.1.1 is, the higher is its profitability. period Return-on-assets assessment) -0,020 finrou, cdev, landgr 0,113

H4.1.1 is, the higher is its profitability. period Return-on-assets (criteria) -0,024 finrou, cdev, landgr 0,107
Table 29: Statistical results for hypothesis 4.1.1
194
In Table 30, the results for the tests of the relationship between corporate governance
quality and the growth of portfolio companies are presented. It was derived from
theory that better corporate governance should contribute to a stronger growth of the
portfolio companies. This was tested as before with the two corporate governance
measures, different measures for growth (employees, sales, cashflows), and taking into
account that the impact might be observable in the same or the next period. Never-
theless, the analyses did not deliver a significant result. All tests had a comparatively
low R2, and none of the coefficients related to the explanatory variables was signifi-
cant at the minimum confidence level of 90%. Although most of these coefficients
were positive, i.e., generally corresponded to the hypothesis, some of them were nega-
tive. On the basis of these results, the hypothesis can be neither supported nor rejected.

H4.1.2 is, the higher is its growth. period Growth in employees assessment) -0,366 finrou, cdev, landgr 0,017

H4.1.2 is, the higher is its growth. period Growth in employees (criteria) -0,083 finrou, cdev, landgr 0,012

H4.1.2 is, the higher is its growth. period Growth in employees assessment) 0,139 finrou, cdev, landgr 0,031

H4.1.2 is, the higher is its growth. period Growth in employees (criteria) 0,195 finrou, cdev, landgr 0,026

H4.1.2 is, the higher is its growth. period Growth in sales assessment) -0,182 finrou, cdev, landgr 0,057

H4.1.2 is, the higher is its growth. period Growth in sales (criteria) 0,303 finrou, cdev, landgr 0,061

H4.1.2 is, the higher is its growth. period Growth in sales assessment) -0,122 finrou, cdev, landgr 0,061

H4.1.2 is, the higher is its growth. period Growth in sales (criteria) 0,525 finrou, cdev, landgr 0,068

H4.1.2 is, the higher is its growth. period Growth in cashflows assessment) 0,028 finrou, cdev, landgr 0,012

H4.1.2 is, the higher is its growth. period Growth in cashflows (criteria) -0,03 finrou, cdev, landgr 0,010

H4.1.2 is, the higher is its growth. period Growth in cashflows assessment) 0,457 finrou, cdev, landgr 0,035

H4.1.2 is, the higher is its growth. period Growth in cashflows (criteria) -0,056 finrou, cdev, landgr 0,033
195
Next, whether corporate governance quality has a positive impact on the valuation of
portfolio companies is analysed (H4.2). This is done first with a self-assessment by the
respondents as a response variable. They were asked to assess how the valuation
changed between the financing rounds on a scale from "– –" to "++". Although the R2
is 0,298 for the test with the corporate governance quality measured by self-assess-
ment and 0,305 for the test with the corporate governance quality measured by criteria,
there were no significant results. The coefficients for the explanatory variables are
very low and fluctuate around zero (Table 31), so this hypothesis cannot be supported.
The corporate governance

quality of a company has positive Change of valuation
effects on its fundamental between financing CG quality index (self- pcindust, cempngr,
H4.2 performance. S rounds assessment) 0,008 finrou, cdev, landgr 0,298
The corporate governance
quality of a company has positive Change of valuation
effects on its fundamental between financing CG quality index pcindust, cempngr,
H4.2 performance. C rounds (criteria) -0,004 finrou, cdev, landgr 0,305
Table 31: Statistical results for hypothesis 4.2
Finally, the hypothesis was also tested with criteria, namely the percentage change of
the sales and EBITDA multiples used in the different financing rounds, i.e., the change
between the first and second financing rounds and the change between the second and
third financing rounds. The R2 of these four analyses (taking into account the two
measures of corporate governance) are relatively high, ranging between 0,271 and
0,626. Similarly, the coefficients of corporate governance quality as an explanatory
variable are comparatively high, but they are positive for the self-assessment measures
and negative for the measures by criteria. However, only one of the tests using the
mixed models technique delivered a significant result at the 95% level. Corporate
governance quality measured by self-assessment has a strong positive effect on the
EBITDA multiples used for the valuation of portfolio companies. The coefficient is in
this case 2,301, as Table 32 shows. These findings indicate that the hypothesis is partly
supported. Self-assessed corporate governance quality seems to have a positive impact
on the valuation of the portfolio companies, but a significant impact was found only
for the EBITDA multiple.
196

governance quality of a portfolio
company, the higher is its CG quality index (self- pcindust, cempngr,
H4.2.1 valuation. S Change of sales multiple assessment) 1,898 finrou, cdev, landgr 0,626
company, the higher is its CG quality index pcindust, cempngr,
H4.2.1 valuation. C Change of sales multiple (criteria) -1,051 finrou, cdev, landgr 0,550
company, the higher is its Change of EBITDA CG quality index (self- pcindust, cempngr,
H4.2.1 valuation. S multiple assessment) 2,301** finrou, cdev, landgr 0,271
company, the higher is its Change of EBITDA CG quality index pcindust, cempngr,
H4.2.1 valuation. C multiple (criteria) -2,015 finrou, cdev, landgr 0,336
To summarise the findings of these analyses, Figure 56 indicates whether the five
hypotheses are supported or not. In this case, three of them are partly supported ("~")
and for two hypotheses, there was no significant finding ("?").
H4.1 The corporate governance quality of company has effects on its fundamental
performance. ~
H4.1.1 The better the corporate governance quality of a company is, the higher is its
profitability. ~
H4.1.2 The better the corporate governance quality of a company, the higher is its growth. ?
H4.2 The corporate governance quality of a company has positive effects on its fundamental
performance.
?
H4.2.1 The better the corporate governance quality of a portfolio company, the higher is its
valuation. ~
Figure 56: Overview of the results for hypotheses about the relationship between corporate governance
quality and firm value
197
6 Conclusion
This chapter summarises the key results of the research and answers the research
questions. In a second step, these findings are discussed taking into account limitations
and relations with the results of earlier research. Finally, an outlook is given that
directs the need for further research on the basis of this analysis.
6.1 Summary of Results

The analysis is intended to answer two key research questions derived from the
literature in the fields of venture capital and corporate governance:
How do venture capitalists influence the corporate governance of portfolio

companies throughout their development?
What are the effects of good corporate governance on the firm value of growth
companies?
The research questions comprise the following four aspects, which focus on the
relationship between venture capital, corporate governance and firm value:
the venture capitalists' reasons for influencing corporate governance
the effects of their influence on corporate governance
the impact of the venture capitalists' abilities
the effects of good corporate governance on firm value.
To answer these two research questions, three distinct analyses were undertaken. First,
a theoretical analysis on the basis of agency theory and the dynamic resource-based
view were done. The combination of an economic and a managerial theory ensured a
comprehensive picture. The results of this theoretical analysis were hypotheses that
were tested in an empirical analysis. Second, a qualitative empirical analysis was
carried out with expert interviews in several European countries that delivered first
findings on the verification of the hypotheses and helped to prepare the questionnaire.
Finally, a large-scale quantitative analysis of portfolio companies across Europe was
done to collect data to test the hypotheses. For the tests, uni- and multivariate
199
statistical techniques were used. According to the three-step approach of the research,
the main findings for the two research questions are presented in the following.
6.1.1 Influence of Venture Capital on Corporate Governance

The first research question analyses how venture capitalists influence the corporate
governance of their portfolio companies and thereby encompasses three aspects. The
reasons venture capitalists influence corporate governance are analysed first. In a
second step, it is researched what impact the influence has and whether the impact is
determined by the venture capitalists’ abilities. According to agency theory, the
venture capitalists influence corporate governance to reduce the risk of their invest-
ments. The strength of their influence should thereafter be determined by the agency
and business risk of the portfolio company. Consequently, they should focus on the
elements associated with the control and bonding functions of corporate governance,
such as the assessment and bonding of managers, the independence of the board, and
the reporting discipline. The key condition for the venture capitalists’ impact on these
elements is that they possess sufficient control rights to enforce their goals, in
particular voting rights and board seats. By contrast, the dynamic resource-based
view considers good corporate governance as a valuable resource to achieve a compe-
titive advantage. Hence, venture capitalists should improve the corporate governance
of their portfolio companies in order to increase their value by creating a better compe-
titive position. However, a competitive advantage can only be built on a good basis, so
venture capitalists are expected to focus their influence on companies that already have
comparatively good corporate governance. Value creation through good corporate
governance is particularly associated with the advice function. To improve these
elements, such as the selection of managers, the qualification of board members and
the involvement of board members in the strategic decision making process, venture
capitalists need relevant experience and capabilities. These required abilities refer to
characteristics of the venture capital firms and the investment managers who work for
them and include, for example, the type of the venture capital firm and experience in
the venture capital industry and the portfolio companies’ industries. A third reason for
venture capitalists to influence the corporate governance of their portfolio companies,
apart from risk reduction and value creation, is the optimal preparation of a portfolio
company about to issue its shares publicly. In this case, it is also expected that venture
capitalists increase their influence, in particular to ensure that the portfolio company
complies with required corporate governance rules and to send a quality signal to the
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market by bringing reputable board members into the company. The reasons for the
venture capitalists' influence could change over time, as they have to decide where
their investment of resources is most promising. Accordingly, it is expected that the
focus changes from risk reduction in the early phase of an investment when it is
difficult to differentiate between more- and less-promising portfolio companies to
value creation at later phases where it might be possible to make this differentiation.
While the reasons, the focus and the required abilities of the venture capitalists differ
for the explanations of the two theories, both theories predict that venture capitalist
influence improves the corporate governance of the portfolio companies. This theo-
retic analysis resulted in hypotheses that were tested empirically.
During the interviews with venture capitalists and managers of portfolio companies, it
was attempted to translate the relationships that were derived from theory into
practice. It was found that the venture capitalists take standard measures to influence
corporate governance, mostly during the contracting phase. However, the extent of
these measures depends on their negotiating power. For example, in the case of bad
performance, these measures might be adapted. In particular, the interviewees from
portfolio companies revealed that venture capitalists are not always in a position to
push through strict burdens for the managers. They also recognised differences in the
approaches and effectiveness of venture capitalists. Several venture capitalists stressed
that trust plays an important role because their influence might only be effective if the
managers of the portfolio companies trust them. This emphasises that venture
capitalists might not always be able to enforce their measures on the corporate gover-
nance of portfolio companies. The reason for their influence is mainly explained by
risk reduction and exit preparation. In contrast, corporate governance is generally not
seen as a key to improve portfolio companies’ competitive positions.
The results from the quantitative analysis are mixed. For the hypothesis on the
reasons, only very weak support was found. The agency and business risk that were
expected to increase venture capitalists’ influence were not in a significant relationship
with the strength of the influence, and the findings rather indicated a negative than a
positive influence. Corporate governance quality — referring to the value creation
hypotheses derived from the dynamic resource-based view — was also significantly
related to the venture capitalists’ influence in only a very few cases, and the impact
was very low. However, the impact of corporate governance quality on the venture
capitalists' influence on the corporate governance is significant when the analysis is
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done for the second and third financing rounds. This indicates that value creation
might be a reason only at a later point when the potential of a portfolio company and
the adequacy of its corporate governance can be assessed.
In contrast to these limited findings, the effects of a potential IPO were more
significant. According to the results, a portfolio company will more probably comply
with a corporate governance code and have board members with experience from
listed companies when it plans a public offering than when it does not. The venture
capitalists' influence is, in the beginning, focussed on the corporate governance
bonding and monitoring function whereas in the later financing rounds, the advice
function becomes comparatively more important.
There are relatively strong differences in the assessment of the portfolio companies'
corporate governance quality between the measurement by self-assessment of the
respondents and the measurement by criteria. Although the quality of all individual
elements is rather similar in the perception of the respondents, there are strong diffe-
rences when the fulfilment of criteria is analysed. In particular, the criteria related to
the compensation of the managers as well as the composition and work of the board
are less often fulfilled than those of the other elements. However, the quality of all
corporate governance elements increases significantly with venture capitalist
financing.
Similarly, the majority of the hypotheses that predict a positive relationship between
venture capitalists' influence and the portfolio companies' corporate governance are
supported. Particularly strong is the impact of venture capitalists on the adequacy of
managers' compensation, the composition of the board and the reporting discipline. In
some cases, there are differences between the assessments by self-assessment and
those by criteria; mostly the significance is stronger for the self-assessment measures.
In regard to abilities, it was distinguished between the control rights of the venture
capitalists, the characteristics of the lead venture capital firms and the characteristics
of the investment managers. Although the general hypothesis that stronger abilities of
the venture capitalists lead to better corporate governance in the portfolio companies is
supported, the significance of the positive impact of the control rights is weak. In
contrast, the findings on the abilities of venture capital firms and particularly of the
investment managers are more significant. Independent venture capital firms, for
example, might have a stronger impact than other types of venture capital firms.
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Moreover, the investment managers' experience in the venture capital industry, in the
industry of the portfolio companies, and internationally also positively affect corporate
governance. Apart from that, a strong impact on the corporate governance quality
measured by self-assessment derives from the trust between the venture capitalists and
the managers of portfolio companies. Hence, although the reasons of the venture
capitalists might be not very clear, their influence has a strongly positive effect on
most corporate governance elements in the portfolio companies. This is supported not
only by the statistical analyses but also by the respondents' perceptions. The majority
of them perceived a positive or very positive impact on corporate governance as a
result of the venture capitalists' influence. Additionally, the abilities of the venture
capitalists determine how strong the improvement of the corporate governance is.
6.1.2 Influence of Corporate Governance on Firm Value

The second research question deals with the effects of good corporate governance on
the firm value of portfolio companies. As the increase of the companies’ value is the
primary motivation for venture capitalists, this relationship is also expected to support
their influence on corporate governance. The two underlying theories of this research
both support the hypothesis that better corporate governance results in a higher firm
value. According to agency theory, good corporate governance should reduce agency
costs that arise from the diverging interests of the venture capitalists and the managers
of the portfolio companies. Agency problems such as consumption on the job and not
carrying out cashflow-positive but risky projects that incur costs for the venture
capitalists might be prevented by effective oversight of the portfolio companies. The
resulting lower costs should lead to improved performance and a better valuation of
the companies. By contrast, the dynamic resource-based view considers the better
competitiveness that could be reached through good corporate governance as the
reason for a higher firm value. In particular, good corporate governance should lead to
better-informed decision making that could lead to better decisions and ultimately to a
better competitive position. Good corporate governance should thereafter be related to
high firm value in terms of both performance and valuation. This shows that agency
theory explains the relationship between corporate governance and firm value as
reduced costs whereas the dynamic resource-based view explains it as higher compe-
titiveness.
During the qualitative analysis, the interviewees brought up some examples that
support the hypothesis that corporate governance and firm value are positively related.
203
Venture capitalists delivered examples of situations in which their oversight of
portfolio companies prevented unnecessary costs. One portfolio company manager
cited an example of the positive effect of good corporate governance on the decision
making process. Generally, the interviewees supported the notion that good corporate
governance increases firm value, though they also stated that bad corporate gover-
nance does not inevitably lead to bad performance. Furthermore, venture capitalists
denied that they pay a premium for companies with good corporate governance, but
they said would consider a deduction in the case of bad corporate governance — for
example for the lack of complete reports about the historic development of a company.
Furthermore, the interviewees stressed that good corporate governance in the case of
growth companies might not be well assessed by the criteria of corporate governance
codes because they neglect the particular and changing requirements of these
companies. Therefore, the majority of the respondents doubted that an analysis of the
relationship between the fulfilment of corporate governance criteria and the portfolio
companies’ firm value would lead to significant results, although they supported the
general notion.
In the survey, data on the portfolio companies' performance and valuation were
collected in order to analyse their relationship with corporate governance quality. The
results of the statistical tests delivered only weak support for the hypothesis of a
positive relationship. In most cases the impact was not significant or only very weak.
In regard to the companies' performance, support was found for the tests that related
corporate governance quality to the return on equity and, to a lesser extent, to the net
profit margin and the return on assets. Although the impact was observed after a time
lag for the first measure, the effects on the other two measures were observed without
delay. There was no significant relationship found for any of the growth measures. The
results for the valuation measures are also mixed. The only significant and relatively
strong positive impact of good corporate governance was found on the EBITDA
multiple. That means that better-perceived corporate governance led to a higher
EBITDA multiple used for the portfolio companies' valuation in the next financing
round. The limited significant findings for these hypotheses might be due to a reduced
number of responses from the portfolio companies. The perception of the respondents
regarding the effects of good corporate governance on firm value is similar. Although
there is a tendency to support a positive impact, the biggest group of respondents did
not perceive any effect. Consequently, on the basis of the findings, the hypotheses can
204
be weakly supported because all significant tests deliver results that correspond to the
expectations.
In a nutshell, the findings narrowed the knowledge gap in regard to the two research
questions in a significant way, which was made possible by an adequate research
approach. Venture capitalists influence all six analysed corporate governance
elements. Their motivations are the preparation of an IPO and, at later financing
rounds, the improvement of corporate governance to build a competitive advantage on
good decision making. With their influence, venture capitalists strongly improve all
the analysed corporate governance elements of their portfolio companies. This is
shown by both measures, the self-assessments by the managers of the portfolio compa-
nies and the fulfilment of criteria for good corporate governance. The abilities of the
venture capitalists play an important role on their impact on corporate governance. In
particular, the venture capital firms' and the investment managers' characteristics can
lead to a reinforced positive impact. Finally, the positive impact on corporate gover-
nance also has a positive impact on the portfolio companies' firm value. For some of
the measures of profitability and valuation, a significant impact was found. In one
sentence: Venture capitalists increase the value of their portfolio companies by
improving their corporate governance.
6.2 Discussion
6.2.1 Limitations of the Analyses
When the results of these analyses are discussed, the limitations of the research have to
be taken into account. The limitations are related to the original sample of the
empirical analyses, the respondents whose answers were considered, the quality of the
information that was collected, and the explanatory power of the results of the
analyses.
The sample of the qualitative and quantitative analysis might be affected by survival
and selection bias. First, only surviving companies are included in the research. That
means that relatively unsuccessful companies that do not exist anymore were not
analysed, although retrospective questions ask about times at which such companies
might still have been active. As a result, the results might be relevant only for
successful growth companies. Second, there is a selection bias because venture
capitalists are expected to invest only in relatively promising companies. This
selection might have an impact on the sample because it includes only companies that
205
have better prospects than other companies. The bias that comes from the selection
may affect the companies’ development as much as the venture capitalists’ influence.
However, because the statistical analyses were controlled for the original status of all
response variables, this bias should be attenuated.
As has been shown before, the respondents geographically correspond to the original
sample. However, in terms of company age, the 139 respondents are comparatively
younger than the companies included in the sample. This might be due to aged data
in the database from which the sample was collected, i.e., it is supposable that not all
companies in the original sample are still active and venture capital-financed. Never-
theless, because there are relatively few older companies among the respondents, the
findings might underestimate information from older venture capital-financed
companies.
Further limitations are related to the data quality. The questionnaire collected
retrospective information, which can biased because the respondents might not be able
to give objective information on an earlier situation. However, the responses demon-
strate that the respondents significantly differentiated between their answers for
different measuring times, in particular for the time before and after the first financing
round. Apart from that, the explanatory value of the results from the third and fourth
measuring times (after the second/third financing round) is limited because of a
relatively small number of responses. A relatively low number of the respondents had
had two or three financing rounds at the time they completed the questionnaire, so
those results might be more susceptible to the influence of outliers. Hence, the expla-
natory value of the results decreases with the number of financing rounds. However, in
the analyses for the first two measuring times, all companies were taken into account
so that for these results the representativeness is ensured. Moreover, the corporate
governance quality was measured in two ways: by the self-assessment of the
respondents and by criteria for good corporate governance. The correlation of the two
measures is not very high, which means that the managers of the portfolio companies
do not always consider the criteria as adequate for their company in its particular
situation. This leads to partly differing results when the two measures are used to
analyse the impact on or the impact of corporate governance quality. The research
cannot deliver an answer as to which measure is better suited for the analysis of
corporate governance. Moreover, the analysis of the portfolio companies’ performance
is done for the time before the first financing round by a venture capitalist and after
206
every financing round. This is done to collect performance data that correspond to the
measuring times of the other information. But it is not assumed that performance per
se has a relationship to venture capitalist financing of portfolio companies. To prevent
influences from performance differences before the venture capitalists’ investments,
the analyses were controlled for the company performance before the first financing
round.
Finally, research on corporate governance is affected by endogeneity or reverse

causality.542 This general problem relates to the relationship of corporate governance
and firm value because these two variables are interrelated. Although corporate
governance is expected to influence firm value, it might also be the case that firm
value influences corporate governance. An example of this problem is research on the
relationship between ownership and performance:543 not only can the ownership have
an impact on the performance, but managerial ownership, for example, could depend
on the previous performance of the company. The direction of the influence can in
most cases not be clearly observed because the analyses use cross-sectional data that
do not allow correcting for unobserved firm heterogeneity. Nonetheless, the use of
panel data can help identify the causality. Therefore, this quantitative analysis takes
into account time series data that track the development of growth companies to
reduce the problem of endogeneity.
These limitations are taken into account in the interpretation of the results presented in
the next section.
6.2.2 Interpretation of Results

The interpretation of the results is structured along the four aspects of the research
questions. It thereby brings together the results of the three undertaken analyses
summarised before. The particularities of these findings in regard to the different
analyses as well as to earlier research are discussed in the following.
6.2.2.1 Influence of Venture Capitalists on Corporate Governance

In regard to the first aspect of the analyses, the reasons venture capitalists influence
corporate governance, the findings partly contradict the expectations and differ
542
Börsch-Supan/Köke (2002), pp. 295ff.
543
Demsetz/Lehn (1985); Morck et al. (1988).
207
between the analyses. Against several earlier analyses544 that predicted that agency
problems, and thereby agency and business risks, are the main reasons for venture
capitalists to influence the corporate governance of their portfolio companies, this
quantitative analysis did not deliver significant results in this respect. As the measures
for the agency and business risks were derived from those analyses,545 it is unlikely that
this is due to a bad measurement. These results could, however, be traced back to two
explanations.
First, agency and business risks could be generally behind the venture capitalists'
influence on corporate governance, but the venture capitalists might not adapt their
influence according to the level of risk. The interviewed venture capitalists agreed that
risk reduction is their main motivation for influencing portfolio companies' corporate
governance. This was confirmed by a specialist lawyer who deals with the contracts of
several venture capitalists. He saw a similar approach of all venture capitalists regar-
ding the corporate governance elements related to the monitoring and bonding func-
tion. He described the majority of the elements that were looked at in this analysis as
standard measures included in all contracts. Hence, the elements on which agency and
business risks are expected to have an influence are not dependent on the characteri-
stics of a particular portfolio company but are enforced in all cases. This might be the
reason why a significant relationship between the level of agency and business risks
and the influence on corporate governance could not be found in the quantitative
analysis.
Second, these results might be due to the venture capitalists' notion that they cannot
always push their goals through, which might make them unlikely to increase their
influence on the corporate governance even in the case of portfolio companies with
great risks. The interviews revealed that the level of influence depends on the venture
capitalists' power, i.e., if the founder managers have much power because of a good
negotiating position, venture capitalists will not invest much effort to influence the
company because they know that their impact might be limited. But in these cases in
which the managers have great power, the agency risks are expected to be particularly
strong. Thus, there might be cases with high agency and business risks in which
venture capitalists do not invest resources to exert influence on corporate governance.
544
E.g. Fiet (1991), Fiert (1995), Sapienza/Gupta (1994), Sapienza et al. (1996), Gompers/Lerner (2004)
545
E. g. Barney et al. (1989); Barney et al. (1994); Sapienza/Gupta (1994); Fredriksen/Klofsten (2001); Fiert
(1995).
208
Accordingly, it could be difficult to find empirical support for the hypothesis that the
strength of the venture capitalists' influence depends on the agency and business risks
associated with the portfolio companies. Nevertheless, the general notion that venture
capitalists' introduce measures for risk reduction might still hold, as the interviews
showed.
There was also only weak empirical support for the hypotheses related to value
creation as a reason for venture capitalists' influence. However, the attempt to test
these analyses at later measuring times was more promising. Due to the limited data
availability for the third and fourth measuring times, the possibility of receiving signi-
ficant results is relatively low. Nevertheless, the analysis of the basic hypothesis
delivered significant support for the idea that corporate governance quality has an
impact on the influence of venture capitalists in subsequent financing rounds. This can
be explained by the fact that they can differ between companies with better and worse
corporate governance only after they have invested in the company for some time. It
would need further research to derive stronger support for this notion. All in all, even
if the reasons of venture capitalists for influencing corporate governance have been
intensively researched in the past, these results reveal that the associated relations are
still not fully understood.
The effects of venture capitalists’ influence on corporate governance quality are

the second aspect that was analysed. Here the focus of the discussion is the differing
findings for corporate governance quality measured by self-assessment and by criteria.
In particular, for the first measuring time, the quality of the corporate governance
elements was perceived relatively better by the respondents than measured by the
criteria. Even in cases where several criteria were not fulfilled, the respondents
assessed corporate was as relatively adequate. This is in accordance with the
statements of several interviewees that some of the corporate governance elements
might not be adequate for growth companies at an early point of the lifecycle.
Although the differences between the two measures decrease at later measuring times,
they remain relatively strong for three of the corporate governance elements: the
compensation of managers and the composition and work of the board. This indicates
that, from the respondents' point of view, the criteria associated with these elements
are of relatively little importance. This also influences the tests on the impact of the
venture capitalists' influence on corporate governance. Although both measures
delivered significant support for most of the hypotheses, the strength of the impact
209
often differed. In the majority of cases in which a particularly strong influence was
found, the quality was measured by criteria. This concerns, for example, the
assessment and compensation of managers, the qualification of board members and the
reporting discipline. It shows that the venture capitalists obviously influence portfolio
companies to fulfil many of the corporate governance criteria that the respondents
perceive as less important. Given the consistent results on the hypotheses related to the
relationship of venture capitalists' influence and corporate governance quality, it seems
that investors are an important driver of the development of corporate governance.
The results for the third aspect of the first research question concern the impact of the
venture capitalists' abilities on the corporate governance quality of portfolio
companies. The interviewed managers of portfolio companies stressed the importance
of control rights and trust on the impact of venture capitalists. Corresponding to earlier
research,546 the quantitative analysis also delivered support for the importance of
control rights when measurement by criteria was used. However, when the respon-
dents' point of view is taken into account with the measurement by self-assessment,
then no significant results are found. This reveals differences between the results of
analyses using the corporate governance measures by criteria and those using self-
assessment. Although most tests delivered stronger support for the hypotheses when
the measures by criteria were used, the impact of the characteristics of venture capital-
firms and investment managers is also strong when self-assessment measures are used.
Furthermore, the strong impact of trust between the venture capitalists' investment
managers and the managers of the portfolio companies could significantly only be
shown using self-assessment measures. This indicates that the differences in the
findings might have to do with a biased view of the respondents. They might overrate
the positive impact of the venture capitalists' influence and of corporate governance
quality as well as the qualification of the investment managers, if they have good co-
operation. Because the research on the impact of venture capitalists' abilities apart
from the control rights is still very limited, further analyses will be required to better
understand these relationships.
546
E.g. Kaplan/Strömberg (2003), pp. 289ff.; Baker/Gompers (2003), pp. 576ff.; Bouresli et a. (2004), p. 80.
210
6.2.2.2 Influence of Corporate Governance on Firm Value
The second research question deals with the impact of good corporate governance
on firm value. The theory-based hypothesis that corporate governance has a positive
impact on the performance and valuation of companies was tested empirically for the
first time for venture capital-financed growth companies. Earlier empirical research
always concentrated on established public companies, and the results did not always
deliver support for the hypothesis.547 Similar to the mixed results in previous studies,
these analyses also did not deliver consistent results. Although the interviewees of the
qualitative analysis supported the general notion that good corporate governance
should lead to improved firm value, the majority doubted that this could be shown in a
quantitative analysis. When the impact on fundamental performance was analysed,
statistically significant but relatively weak support was found when relative measures
were used. The tests that included criteria for profitability corresponded partly to the
hypothesis. Generally, the support was stronger when self-assessed corporate gover-
nance quality was used as an explanatory variable. Whereas corporate governance's
impact on the net profit margin and the return on assets was observed without a time
lag, an effect on the return on equity could be observed only with a time lag of one
period. In particular, the difference between the tests of the last two measures could
only be explained by effects from the capital structure of the companies. Against
expectations, the companies must be heavily financed by debt.548 Although there was
some support for a positive impact on the companies' profitability, the quantitative
analysis on the impact on the companies' growth did not deliver any significant results.
Just as the interviewees did not back this hypothesis, the research did not deliver
support for a relationship between good corporate governance and firm growth.
The last hypothesis of this research deals with the expected positive impact of
corporate governance on the portfolio companies' valuation. Some of the interviewed
venture capitalists stated that they would consider reducing the valuation of a company
if it could not provide complete reports about its previous development, which would
be an example of bad corporate governance. None of the interviewees would, in
contrast, be prepared to pay a premium for a company with good corporate gover-
nance. Nonetheless, the statistical tests of the results from the survey delivered positive
547
E.g., Gompers et al. (2003), p. 129; Bauer et al. (2993), pp. 13ff.; Beiner et al. (2004), pp. 33.
548
This is only expected for later stage companies, but their proportion in the analysis is not too strong.
There is no information on the portfolio companies' capital structure available.
211
and relatively strong support for the hypothesis when the EBITDA multiple is used.
However, it is remarkable that the two measures of corporate governance differ
strongly in their impact. Whereas the impact of corporate governance measured by
criteria on the sales and EBITDA multiples are strongly negative but insignificant, the
impact of corporate governance measured by self-assessment is strongly positive and
partly significant. The other valuation measures did not significantly support or
contradict the hypothesis. Hence, further research is required here to clarify the
relationship between corporate governance quality and the valuation of growth
companies.
The results related to the impact of corporate governance quality on portfolio

companies' performance and valuation reveal differences in the value effects of the
two corporate governance measures. Apart from one exception, all analyses with signi-
ficant results included the self-assessed corporate governance quality as the explana-
tory variable. If good corporate governance should, according to its definition and the
theory, result in a high firm value, then this would indicate that for growth companies,
self-assessment of the adequacy of corporate governance elements would be a better
measure than measurement by criteria. However, this finding could also be due to the
fact that the respondents defined the adequacy of the corporate governance according
to the companies' performance. This relates to the problem of endogeneity of corporate
governance and firm value because both variables influence each other, so it is
difficult to explain causality.
As this interpretation of the results shows, this research has advanced knowledge about
the relationship of venture capital and the corporate governance and firm value of
portfolio companies considerably, but it also poses new questions. The following
outlook therefore introduces the need for further research.
6.3 Outlook
The theoretical and empirical analyses included a novel approach with distinct
improvements over earlier research,549 particularly in regard to four aspects. To begin
with, this research is among the first on corporate governance that focuses on private
growth companies instead of established public companies. Thus, it enables a view on
the development of corporate governance from founding to the public or private sale
212
of the company, where there is greater firm heterogeneity in regard to corporate
governance. Second, the research is not only based on agency theory but introduces a
new theoretical perspective to corporate governance: the dynamic resource-based
view. These two theories explain the demand and the effects of good corporate gover-
nance from different angles. The combination of an economic and a managerial theory
ensures a more comprehensive picture than either could provide alone. Whereas
agency theory focuses on the problems that the managers of the portfolio companies'
can create for venture capitalists, the dynamic resource-based view considers them an
asset with upside potential. As the findings on the relationship between venture capital
and corporate governance indicate, the dynamic resource-based view is well suited to
complement agency theory. Third, the empirical research of the theoretical findings is
done with both qualitative and quantitative analyses. Triangulation of the results
increases their explanatory power by preventing single-method bias. The expert
interviews increased the understanding of the relationships between venture capital,
corporate governance and firm value. That understanding was used to complement the
hypotheses derived from theory and to prepare the survey. Thus the interviews ensured
reliable results from the quantitative analysis. The pan-European survey was done to
gather generalisable information for testing the hypotheses of the research using uni-
and multivariate analyses. The findings of both studies were jointly interpreted.
Fourth, during the empirical analyses, longitudinal data were collected to research the
development of corporate governance. This provides a unique data set covering up to
five measuring times in the development of growth companies. It enables tracking of
the development of corporate governance and thereby reduces the problem of
endogeneity.
These innovative aspects of the research enabled the collection of significant results
about the relationship between venture capitalists' influence, the quality of corporate
governance and the firm value of portfolio companies. In particular, it was found that
venture capitalists improve the corporate governance quality of their portfolio
companies significantly. Their abilities, and in particular the characteristics of the
investment managers and the trust they develop with the managers of portfolio
companies, have an additional positive impact on corporate governance quality. This
549
For an overview of the methods used in earlier research on entrepreneurship and the associated problems,
refer to Shane/Venkataraman (2000), pp. 217ff.
213
improvement leads to a increased profitability of portfolio companies and partly to an
increased valuation at a future financing round.
Nonetheless, the analyses revealed the need for further research in this area because
most of the aspects are still not fully understood. There are in particular three areas
that should be analysed in the future based on these results. First, the venture
capitalists' reasons for influencing corporate governance are expected to change over
time. This has not been taken into account by other studies that focus primarily on
agency theory. Thus, they neglect that venture capitalists might not invest resources in
companies with agency problems after some time. Because only a few investments are
expected to be successful, venture capitalists might instead focus on investments with
relatively more potential and improve their corporate governance. This notion is not
supported by agency theory. Therefore, future research should be based on a second
theoretic perspective, such as a resource-based view or stewardship theory, that has a
more positivist perspective. The research requires longitudinal data to track develop-
ment. A qualitative approach to this topic might be useful because it captures a more
comprehensive picture. Moreover, the new findings on the importance of the abilities
of investment managers suggest further research of venture capitalist value creation on
this level. As the comparison of the impact of the characteristics of venture capital
firms and investment managers indicates, stronger differences are found there.
Accordingly, the analysis of the impact of the experience and capabilities of
investment managers should be a rich area for research that advances the knowledge
on the value creation of venture capitalists. It could also be used to develop a profile
for ideal candidates for venture capitalists. For that, a more detailed analysis on the
characteristics of investment managers and their impact is required. Such an analysis
should combine the research in the areas of venture capital and human resources and
would thereby open a new stream of research. Finally, a striking finding of this
research is the different results of the two measures of corporate governance, which is
emphasised by the statements of the interviewees. The criteria for good corporate
governance derived from theory, venture capital practice and corporate governance
codes seem to be not equally adequate during the development of growth companies.
Therefore, further research should focus on the question of which elements are
important at specific development stages. The adequacy of the elements could thereby
be defined by the analysis of their value effect, i.e., those elements that increase firm
value should be considered adequate. A longitudinal analysis could advance the know-
ledge of this area, which would be valuable for researchers and practitioners alike.
214
However, high importance must be paid to the problem of endogeneity to ensure
reliable results. This outlook shows that there is a great demand for future research on
the relationship between venture capital, corporate governance and firm value. This
thesis is an early step on the way to closing the existing knowledge gaps.
215
Annex
218
Survey on Venture Capital and Corporate Governance
Thank you for supporting our international research project that is aimed at analysing the influence of venture capitalists on the corporate
Please provide us with information on your company, its corporate governance, and your venture capital and private equity investors on the
following pages. Most of the questions require answers for different points of time, namely the situation after the different financing rounds, in
order to show developments of your company. The average time for completion is approximately 20 minutes. All information will be treated with
highest confidentiality.
The results of the study should provide valuable insight about the corporate governance of growth companies, the support of venture capitalists
and the contribution of corporate governance to the value of companies. You will receive the results after completion of the study in the first half
of 2006.
In case of any question please do not hesitate to contact us:
Email: [email protected]
Phone: +49 (0) 40 - 428 38 40 63
Fax: +49 (0) 40 - 428 38 27 80
This project is supported by the European Venture Capital Association (EVCA) and the Deutsches Venture Capital
Institut
What development stage is the company
currently in?
Seed: before founding of the company Seed
Start-up: after founding of the company Start-up
Expansion: after market entry Expansion
Bridge: preparation of change in Bridge
ownership, e.g. IPO, trade-sale MBO/MBI
MBO/MBI: after separation from parent
company/change in ownership
How many different products/product
lines does the company currently offer? _____________
How many employees does the company
currently have? _____________
How many years has the CEO/managing
_____________years
director worked in the company by now?
Is the current CEO one of the founders of Yes
the company? No
NA
Which legal form has the company?
(e.g. Ltd., SA, AG)
How many financing rounds with 1
participation of venture capitalists have 2
taken place so far? 3 or more
Does the company currently have only
one single board or two separate boards
for management and control (apart from One Board
additional advisory boards)? Two Boards
One board: e.g. board of directors
Two boards: e.g. management and
supervisory board
219
220
Name of venture
Member of After the1st After the 2 nd After the 3rd
capitalist/private
Syndicate financing by VC financing by VC financing by VC
equity firm
Owner-ship Seat on Ownership Seat on Ownership Seat on
Board Board Board
VC 1: _____________ _____% _____%
_____%
VC 2: _____________ _____% _____% _____%
VC 3: _____________ _____% _____% _____%
VC 4: _____________ _____% _____% _____%
VC 5: _____________ _____% _____% _____%

After the 1st After the 2 nd After the 3rd
financing by VC financing by VC financing by VC
Please indicate the lead Name Name Name
investor for every financing
round, i.e. the investor with _____________ _____________ _____________
the strongest influence on
your company.
Has the investment
manager of the lead-
investor substantial Yes Yes Yes
experience in the following No No No
areas: NA NA NA
Work experience in the
venture capital industry
(> 5 years)?
Yes Yes Yes
Work experience in your
or a elated industry? No No No
NA NA NA
Yes Yes Yes
International work
experience? No No No
NA NA NA
Yes Yes Yes
Start-up experience? No No No
NA NA NA
How trustful was the
relationship with the
investment manager of the
++ + O - -- ++ + O - -- ++ + O - --
lead-investor?
How many times per
quarter did you have
contact with the investment ______Times ______Times ______Times
manager on average
(personally and by phone)?
221
222
Before the 1st After the 1st After the 2 nd After the 3rd
financing by VC financing by VC financing by VC financing by VC
Were the managers
assessed at least once a Yes Yes Yes Yes
year in an effective manner No No No No
by the shareholders and/or NA NA NA NA
the supervisory board?
How effective was the
assessment of the
managers by the ++ + O - -- ++ + O - -- ++ + O - -- ++ + O - --
shareholders/supervisory
board?
If members of the top-
management-team left the
company/were replaced:
how many left/were ______ ______ ______ ______
replaced?
How strong was the
influence of the VCs on the
very strong no infl. very strong no infl. very strong no infl.
company's way to assess its
managers?
When searching for new
managers: Yes Yes Yes Yes
Was a profile of the No No No No
preferred candidate NA NA NA NA
developed?
Yes Yes Yes

Was the network of the
VC used? No No No
NA NA NA
Yes Yes Yes Yes
Was a head-hunter used? No No No No
NA NA NA NA
How effective was the
selection of new ++ + O - -- ++ + O - -- ++ + O - -- ++ + O - --
managers?
How strong was the
company's way of selecting
new managers?
223
224
How many percent of the
company’s shares were
owned by the top- _____% _____% _____% _____%
management team
(accumulated ownership)?
Did the managers have Yes Yes Yes Yes
stock options programmes No No No No
with vesting periods? NA NA NA NA
Yes Yes Yes Yes
Were there non-compete
No No No No
clauses for the managers?
NA NA NA NA
How effectively were the
managers bonded to stay in ++ + O - - ++ + O - -
++ + O - -- ++ + O - --
the company and foster its - -
long-term development?
How strong was the
influence of the VCs on the very strong no very strong no very strong no
very strong no
company's way to bond its infl. infl. infl.
infl.
managers?
Did the manager’s Yes Yes Yes Yes
compensation include an No No No No
annual bonus? NA NA NA NA
Did the manager’s
compensation include a Yes Yes Yes Yes
variable element that was No No No No
linked to the company’s NA
mid- and long-term NA NA NA
development (> 2 years)?
Was the fixed or the
variable compensation Fix Fix Fix Fix
(bonus and mid-/long-term Variable Variable Variable Variable
variable parts) more Equal Equal Equal Equal
important?
How did the overall
manager’s compensation
compare to their potential ++ + O - -- ++ + O - -- ++ + O - -- ++ + O - --
salary in other positions
outside the firm?
How strong were the
manager’s financial
incentives to foster the ++ + O - -- ++ + O - -- ++ + O - -- ++ + O - --
long-term development of
the company?
How strong was the
influence of the VCs on the very strong no very strong no very strong no
company's way to infl. infl. infl.
compensate its managers?
How many members did
the board have? ______ ______ ______ ______
How many non-executive
members did the
board have? ______ ______ ______ ______
225
226
Before the 1st financing After the 1st After the 2 nd After the 3rd
by VC financing by VC financing by VC financing by VC
How many independent
non-executive members,
i.e. not related to any of the
company’s managers, ++ + O - -- ++ + O - -- ++ + O - -- ++ + O - --
employees, shareholders,
suppliers or clients did the
supervisory board have?
Who had the strongest Management Management Management
influence on the selection VC VC VC
of the independent non- Equal Equal Equal
executive members?
Had the management
Yes Yes Yes
influence on the selection
No No No
of the VC’s representative
on the board? NA NA NA
How many of the non-
executive board members
had the following
experiences:
Experience in your or
related industry
______ ______ ______ ______
Executive experience
______ ______ ______ ______
International experience
______ ______ ______ ______
Functional experience in
finance/ marketing/sales
______ ______ ______ ______
Start-up experience
______ ______ ______ ______
Experience as manager
or board member in
______ ______ ______ ______
listed companies
Was the chairman of the Yes Yes Yes Yes
board also the CEO? No No No No
NA NA NA NA
Was the board supported
Yes Yes Yes Yes
by specialised experts as
No No No No
consultants or members of
an advisory board? NA NA NA NA
How well did the non-
executive supervisory
board members meet the ++ + O - -- ++ + O - -- ++ + O - -- ++ + O - --
requirements to effectively
monitor the management?
How well did the non-
executive board members
meet the requirements to ++ + O - -- ++ + O - -- ++ + O - --
effectively advice the
management?
How strong was the
structure of the non-
executive board members?
How often did the board
_____times _____times _____times _____times
meet per year?
Did you provide all board
members with the agenda
and all relevant information always never always never always never always never
well ahead of the board
meeting (>1 week)?
How many hours did the
board meetings take on _____hours _____hours _____hours _____hours
average?
227
228
Did the company have
Yes Yes Yes Yes
documentation of the roles
No No No No
and responsibilities of the
board? NA NA NA NA
What proportion of the time
of board meetings was
spent on average for topics 100 % 100 % 100 % 100 %
related to the following thereof: thereof: thereof: thereof:
areas? Please distribute
100 % to the three areas)
Operational matters _____% _____% _____% _____%
Monitoring matters _____% _____% _____% _____%
Strategic matters _____% _____% _____% _____%
How effectively and
efficiently did the board’s
++ + O - -- ++ + O - -- ++ + O - -- ++ + O - --
work fulfil its monitoring
function?
How effectively and
efficiently did the board’s
++ + O - -- ++ + O - -- ++ + O - -- ++ + O - --
work fulfil its advice
function?
How strong was the
influence of the VCs on the very strong no infl. very strong no infl. very strong no infl.
way the board worked?
How many reports did your
company prepare for the ______ ______ ______ ______
shareholders per year?
What information was
regularly provided in the
reports to shareholders and Yes Yes Yes Yes
supervisory board No No No No
members: NA NA NA NA
Cash-flow-statement
Profit-and-loss-account Yes Yes Yes Yes

No No No No
NA NA NA NA
Balance sheet Yes Yes Yes Yes
No No No No
NA NA NA NA
Qualitative information Yes Yes Yes Yes
on the company’s No No No No
development NA NA NA NA
Information on the Yes Yes Yes Yes
market development No No No No
NA NA NA NA
Target-actual Yes Yes Yes Yes
comparisons No No No No
NA NA NA NA
How great were the
differences in the target- very great no diff. very great no diff. very great no diff. very great no diff.
actual comparisons?
Were the reports provided
always on-time i.e.
provided immediately after ++ + O - -- ++ + O - -- ++ + O - -- ++ + O - --
the end of the reporting
period?
229
230
How sufficient was the
information provided to the
++ + O - -- ++ + O - -- ++ + O - -- ++ + O - --
board and shareholders for
effective monitoring??
How strong was the
company's way of
reporting?
Was the corporate
governance reviewed Yes Yes Yes Yes
regularly by the board or No No No No
the management of the NA NA NA NA
company?
Was the corporate
governance implemented in Yes Yes Yes Yes
order to comply with
No No No No
corporate governance
codes or requirements of NA NA NA NA
stock exchanges?
What impact had the venture capitalist’s influence on the

++ + O - --
professionalization of the corporate governance?
What impact had the quality of corporate governance on your
++ + O - --
company’s performance?
What impact had the quality of corporate governance on your
++ + O - --
company’s valuation?
Before the 1st financing After the 1st After the 2nd After the 3rd
How competitive was the
company relative to its
++ + O - -- ++ + O - -- ++ + O - -- ++ + O - --
direct and indirect
competitors?
Was the company
performing according to ++ + O - -- ++ + O - -- ++ + O - -- ++ + O - --
plan?
Did the owners (VC) plan a
sale of the company?
Seconday sale: sale to Secondary Sale Secondary Sale Secondary Sale Secondary Sale
financial investor Trade Sale Trade Sale Trade Sale Trade Sale
Trade sale: sale to
strategic investor from IPO IPO IPO IPO
related industr
IPO: public offering
What was the average
growth rate of the
_____% _____% _____% _____%
company?
Growth in employees
Growth in sales _____% _____% _____% _____%
Growth in cash-flows _____% _____% _____% _____%
What was the average
performance of the
_____% _____% _____% _____%
company?
EBITDA-margin
Net-profit-margin _____% _____% _____% _____%
Return-on-Equity _____% _____% _____% _____%
Return-on-Assets _____% _____% _____% _____%
231
232
Between the 1st and the 2nd financing Between the 2nd and the 3rd financing
rounds by VC rounds by VC
How did the valuation of the investors change
++ + O - -- ++ + O - --
from one financing round to the next?
How did the multiples used for the company’s
valuation change between financing rounds?
(in case of decrease add "-" e.g. "-10") _____% _____%
Change of sales-multiple in percent
Change of cash-flow-multiple in percent _____% _____%

Change of EBITDA-multiple in percent _____% _____%
Is the product offer of the company of
++ + O - -- ++ + O - --
technological nature?
Is the product offer of the company
++ + O - -- ++ + O - --
innovative?
Is the business of the company highly
++ + O - -- ++ + O - --
specific?
How important are intangible assets for the
++ + O - -- ++ + O - --
company?
Does the top management team of the
company possess: ++ + O - -- ++ + O - --
Start-up experience?
Industry experience? ++ + O - -- ++ + O - --
Functional experience in finance, sales or

marketing?
++ + O - -- ++ + O - --
How dynamic is your market? ++ + O - -- ++ + O - --

How attractive is your market? ++ + O - -- ++ + O - --
Survey on Venture Capital and Corporate Governance
Thank you for taking your time to answer the questionnaire. We highly appreciate your support of our research project.
Please provide us with your e-mail address so that

we can send you the report with the results in the
first half of 2006.
Please feel free to comment the questionnaire or the

topic of the study here:
Annex 1: Questionnaire of the survey
233
Variable Name Description Scale Values Sources
EXPLANATORY VARIABLE
Agency and business risk abind Mean index of the indicators for agency risk: ratio 0-1 Questionnaire,
index m anagerial ownership (dum m y), age of portfolio Database
com pany (interval), specific of the business
(interval), im portance of intangible assets
(interval), degree of technology of product
(interval); and for business risk: CEO is found of
com pany (dum m y), start-up experience of top
m anagem ent team (interval), functional
experience of top m anagem ent team (interval),
num ber of products (dum m y), degree of
dynam ics of industry (interval), attractiveness of
m arket (interval)
CG quality index (self cgqind Mean index of efficiency of assessm ent of ratio 0-1 Questionnaire
assessm ent) m anagers, selection of new m anagers, bonding
of m anagers, com pensation of m anagers,
com position of board (m onitoring and advice),
work of board (m onitoring and advice) and
reporting discipline (all interval)
CG quality index (criteria) cgqinc Mean index of all variables included in the sub- ratio 0-1 Questionnaire
indexes of quality of selection and assessm ent
of m anagers, of com pensation of m anagers, of
bonding of m anagers, of com position of board,
of work of board and of reporting discipline
CG advice index (self cgaind Mean index of efficiency of selection of new ratio 0-1 Questionnaire
assessm ent) m anagers, com position of board (advice) and
work of board (advice; all interval)
Index of quality of selection m seind Mean index of profile of preferred candidate ratio 0-1 Questionnaire
of managers (dum m y) and sources of selection of m anagers
(interval)
Efficiency of com position of bsoae Efficiency assessed by respondend: "--" (1), "-" interval 1-5 Questionnaire
board: advice (2), "o" (3), "+" (4), "++" (5)
Index of quality of board bsiind Mean index of proportion of independent board ratio 0-1 Questionnaire
com position m em bers, board m em bers with industry
experience, executive experience, international
experience, functional experience, startup
experience, experience from listed com panies,
support by experts/consultants, chairm an of
board also CEO, proportion of non-executive
board m em bers (all dum m y)
Efficiency of work of board: bwoae Efficiency assessed by respondend: "--" (1), "-" interval 1-5 Questionnaire
advice (2), "o" (3), "+" (4), "++" (5)
Index of quality of work of bwoind Mean index of num ber of board m eetings, length ratio 0-1 Questionnaire
board of board m eetings, proportion of tim e devoted to
strategic and m onitoring issues and
docum entation of board's responsibilities
CG advice index (criteria) cgacin Mean index of index of quality of selection of ratio 0-1 Questionnaire
m anagers, index of quality of board com position:
qualification and proportion of (board) tim e
devoted to strategic issues
Planned IPO csale 1 if IPO is planned dum m y 0/1 Questionnaire
CONTROL VARIABLES
Developm ent stage of pcfrde/c Developm ent Status of portfolio com pany: ordinal 1-5 Questionnaire,
portfolio com pany dev seed(1), start-up (2), expansion (3), bridge (4), Database
MBO/MBI (5)
Size of portfolio com pany cem pn Number of em ployees: 1-9 (1), 10- 49 (2), 40- interval 1-4 Questionnaire
249 (3), >250 (4)
Region of portfolio landgr Location of portfolio com pany: nom inal 1-6 Database
com pany Germ any/Austria/Switzerland (1),
France/BeNeLux (2), Northern Europe (3),
UK/Ireland (4), Eastern Europe (5), Southern
Europe (6)
Distance venture capitalist- lvcdist Distance between the locations in km : 0-50 (1), interval 1-3 Database
portfolio com pany 51-500 (2), >501 (3)
Annex 2: Variables related to hypotheses on reasons of venture capitalists
234
RESPONSE VARIABLES - SELF ASSESSMENT
CG quality index (self cgqind Mean index of efficiency of assessment of ratio 0-1 Questionnaire
assessment) managers, selection of new managers, bonding
of managers, compensation of managers,
composition of board (monitoring and advice),
work of board (monitoring and advice) and
CG monitoring index (self cgmind Mean index of efficiency of assessment of ratio 0-1 Questionnaire
assessment) managers, composition of board (monitoring),
work of board (monitoring) and reporting
discipline (all interval)
Efficiency of assessment of masse Efficiency assessed by respondend: "--" (1), "-" interval 1-5 Questionnaire
managers (2), "o" (3), "+" (4), "++" (5)
Efficiency of composition of bsome Efficiency assessed by respondend: "--" (1), "-" interval 1-5 Questionnaire
board: monitoring (2), "o" (3), "+" (4), "++" (5)
Efficiency of work of board: bwome Efficiency assessed by respondend: "--" (1), "-" interval 1-5 Questionnaire
monitoring (2), "o" (3), "+" (4), "++" (5)
Efficiency of reporting rmone Efficiency assessed by respondend: "--" (1), "-" interval 1-5 Questionnaire
discipline (2), "o" (3), "+" (4), "++" (5)
CG bonding index (self cgbind Mean index of efficiency of bonding of managers ratio 0-1 Questionnaire
assessment) and compensation of managers (all interval)
Efficiency of bonding of mbone Efficiency assessed by respondend: "--" (1), "-" interval 1-5 Questionnaire
managers (2), "o" (3), "+" (4), "++" (5)
Efficiency of compensation mcome Efficiency assessed by respondend: "--" (1), "-" interval 1-5 Questionnaire
of managers (2), "o" (3), "+" (4), "++" (5)
assessment) managers, composition of board (advice) and
Efficiency of selection of msele Efficiency assessed by respondend: "--" (1), "-" interval 1-5 Questionnaire
new managers (2), "o" (3), "+" (4), "++" (5)
Efficiency of composition of bsoae Efficiency assessed by respondend: "--" (1), "-" interval 1-5 Questionnaire
board: advice (2), "o" (3), "+" (4), "++" (5)
Efficiency of work of board: bwoae Efficiency assessed by respondend: "--" (1), "-" interval 1-5 Questionnaire
advice (2), "o" (3), "+" (4), "++" (5)
Efficiency of assessment maas Mean index of efficiency of assessment and ratio 0-1 Questionnaire
and selection of managers selection of managers (all nterval)

RESPONSE VARIABLES - CRITERIA
indexes of quality of selection and assessment
of managers, of compensation of managers, of
bonding of managers, of composition of board,
CG monitoring index cgmcin Mean index of assesment of managers, ratio 0-1 Questionnaire
(criteria) proportion of independent board members,
index of quality of board except stratetic
invovlement, index of quality of reporting
discipline
CG bonding index (criteria) cgbcin Mean index of index of quality of bonding of ratio 0-1 Questionnaire
managers and index of quality of compensation
of managers
managers, index of quality of board composition:
qualification and proportion of (board) time
235
Conduct of assessment of massn Assessment of managers by board or dummy 0/1 Questionnaire
managers shareholders at least once a year: no (0), yes (1)
Replacements of managers mrepn Number of replacements of managers per ratio >=0 Questionnaire
per financing round financing round
Index of quality of selection mseind Mean index of profile of preferred candidate ratio 0-1 Questionnaire
of managers (dummy) and sources of selection of managers
(interval)
Profile of preferred mselpr Selection of new managers on basis of profile of dummy 0/1 Questionnaire
candidate preferred candidate: no (0), yes (1)
Sources for selection of msels Mean index of use of headhunter and VC's ratio 0-1 Questionnaire
managers network
Use of headhunter mselhh Use of headhunter for selection of new dummy 0/1 Questionnaire
managers: no (0), yes (1)
Use of VC's network mselvc Use of VC's network for selection of new dummy 0/1 Questionnaire
managers: no (0), yes (1)
Index of quality of bonding mboind Mean index of managers with stock-options ratio 0-1 Questionnaire
of managers programmes with vesting period, non-compete
clauses and managerial ownership
Managers with stock mbonop Use of stock options programmes with vesting dummy 0/1 Questionnaire
options programmes with period for managers: no (0), yes (1)
vesting period
Managers with non- mbonnc Use of non-compete clauses for managers: 1/0 dummy 0/1 Questionnaire
compete clauses
Managerial ownership mboow Managers with ownership in company: <1 % (0), dummy 0/1 Questionnaire
n >1 % (1)
Index of quality of mbvin Mean index of managers with annual bonus and ratio 0-1 Questionnaire
compensation of managers variable compensation linked to mid-/long-term
development, importance of annual bonus
versus variable compensation linked to mid-/long-
term development and level of compensation
compared to industry
Managers with annual mcoma Use of annual bonus for managers' dummy 0/1 Questionnaire
bonus b compensation: no (0), yes (1)
Managers with variable mcomv Use of variable compensation linked to mid/long- dummy 0/1 Questionnaire
compensation linked to mid- e term development: no (0), yes (1)
/long-term development
Importance of annual mcomi Most important compensation part: fixed (0), dummy 0/1 Questionnaire
bonus versus variable m equal (1), variable (1)
compensation linked to mid-
/long-term development
Level of compensation mcomc Comparison of managers' compensation with interval 1-5 Questionnaire
compared to industry o potential compensation outside the firm: "--" (1),
"-" (2), "o" (3), "+" (4), "++" (5)
Index of quality of board bsiind Mean index of proportion of independent board ratio 0-1 Questionnaire
composition members, board members with industry
experience, executive experience, international
experience, functional experience, startup
experience, experience from listed companies,
support by expperts/consultants, chairman of
board also CEO, proportion of non-executive
board members (all dummy)
Proportion of independent bspin Number of independent board members / dummy 0/1 Questionnaire
board members number of board members: <50% (0), >=50%
(1)
236
RESPONSE VARIABLES - CRITERIA (contd.)
Index of quality of reporting rind Mean index of number of reports of year, ratio 0-1 Questionnaire
discipline timeliness of reporting, provision of cashflow
statement, profit-and-loss-account, balance
sheet, target-actual comparison, qualitative
information of company, information on market
development and extent of target-actual
differences
Number of reports per year rrn Number of reports per year: <=10 (0), >10 (1) dummy 0/1 Questionnaire
Timeliness of reporting ront Timeliness of reporting: "--" (1), "-" (2), "o" (3), interval 1-5 Questionnaire
"+" (4), "++" (5)
Completeness of reporting rcompr Mean index of provision of cashflow statement, ratio 0-1 Questionnaire
profit-and-loss-account, balance sheet, target-
actual comparison, qualitative information on
company, information on market development,,
extent of target-actual differences
Provision of cashflow rcfs

Provision of cashflow statement in report: no (0), dummy 0/1 Questionnaire
statement yes (1)
Provision of profit-and-loss- rpla
Provision of profit-and-loss-account in report: no dummy 0/1 Questionnaire
account (0), yes (1)
Provision of balance sheet rbs Provision of balance sheet in report: no (0), yes dummy 0/1 Questionnaire
(1)
Provision of target-actual rtac Provision of target-actual comparison in report: dummy 0/1 Questionnaire
comparison no (0), yes (1)
Provision of qualitative rqco Provision of qualitative information in report: no dummy 0/1 Questionnaire
information on company (0), yes (1)
Provision of information on rmda Provision of information on market development dummy 0/1 Questionnaire
market development in report: no (0), yes (1)
Extent of target-actual rdiff Exactness of planning - etent of target actual interval 1-5 Questionnaire
differences comparison: "--" (1), "-" (2), "o" (3), "+" (4), "++"
(5)
EXPLANATORY VARIABLES
Index of VC's influence on vciind Mean index of VC's influence on assessment of ratio 0-1 Questionnaire
all CG elements managers, on selection of new managers, on
bonding of managers, on compensation of
managers on composition of board, on work of
board, on reporting discipline (all interval)
Index of VC's influence on vcimon Mean index of VC's influence on assessment of ratio 0-1 Questionnaire
CG elements with managers, on composition of board, on work of
monitoring function board, on reporting discipline (all interval)
VC's influence on mvci Strength of influence: four answer possibilities interval 1-4 Questionnaire
assessment of managers from "no influence" (1) to "very strong" (4)
VC's influence on bsovci Strength of influence: four answer possibilities interval 1-4 Questionnaire
composition of board from "no influence" (1) to "very strong" (4)
VC's influence on work of bwovci Strength of influence: four answer possibilities interval 1-4 Questionnaire
board from "no influence" (1) to "very strong" (4)
VC's influence on reporting rvci Strength of influence: four answer possibilities interval 1-4 Questionnaire
discipline from "no influence" (1) to "very strong" (4)
237
EXPLANATORY VARIABLES (contd.)
Index of VC's influence on vcibon Mean index of VC's influence on bonding of ratio 0-1 Questionnaire
CG elements with bonding managers and on compensation of managers
function (all interval)
VC's influence on bonding mbovci Strength of influence: four answer possibilities interval 1-4 Questionnaire
of managers from "no influence" (1) to "very strong" (4)
VC's influence on mcovci Strength of influence: four answer possibilities interval 1-4 Questionnaire
compensation of managers from "no influence" (1) to "very strong" (4)
Index of VC's influence on vciadv Mean index of VC's influence on selection of ratio 0-1 Questionnaire
CG elements with advice new managers, on composition of board and on
function work of board (all interval)
VC's influence on selection msevci Strength of influence: four answer possibilities interval 1-4 Questionnaire
of new managers from "no influence" (1) to "very strong" (4)
VC's influence on bsovci Strength of influence: four answer possibilities interval 1-4 Questionnaire
composition of board from "no influence" (1) to "very strong" (4)
VC's influence on work of bwovci Strength of influence: four answer possibilities interval 1-4 Questionnaire
board from "no influence" (1) to "very strong" (4)
CONTROL VARIABLES
Development stage of pcfrde/c Development Status of portfolio company: ordinal 1-5 Questionnaire,
portfolio company dev seed(1), start-up (2), expansion (3), bridge (4), Database
MBO/MBI (5)
Size of portfolio company cempn Number of employees: 1-9 (1), 10- 49 (2), 40- interval 1-4 Questionnaire
249 (3), >250 (4)
Region of portfolio landgr Location of portfolio company: nominal 1-6 Database
company Germany/Austria/Switzerland (1),
Europe (6)
Distance venture capitalist- lvcdist Distance between the locations in km: 0-50 (1), interval 1-3 Database
portfolio company 51-500 (2), >501 (3)
Annex 3: Variables related to hypotheses about corporate governance quality
238
RESPONSE VARIABLES - SELF ASSESSMENT
CG monitoring index (self cgmind Mean index of efficiency of assessment of ratio 0-1 Questionnaire
assessment) managers, composition of board (monitoring),
work of board (monitoring) and reporting
discipline (all interval)
CG bonding index (self cgbind Mean index of efficiency of bonding of managers ratio 0-1 Questionnaire
assessment) and compensation of managers (all interval)
assessment) managers, composition of board (advice) and
CG monitoring index cgmcin Mean index of assesment of managers, ratio 0-1 Questionnaire
(criteria) proportion of independent board members,
index of quality of board except stratetic
invovlement, index of quality of reporting
discipline
CG bonding index (criteria) cgbcin Mean index of index of quality of bonding of ratio 0-1 Questionnaire
managers and index of quality of compensation
of managers
managers, index of quality of board composition:
qualification and proportion of (board) time
EXPLANATORY VARIABLES - ABILITIES
Index of abilities lvcabi Mean index of control rights of lead-VC-F index ratio 0-1 Questionnaire/
and index of abilities of lead-VC-F and IM Database
Control rights of lead-VC-F lvccri Mean index of pwnership rights and board seat ratio 0-1 Questionnaire
index of lead-VC
Ownership rights of lead- lvcown Ownership share of lead-VC in percent ratio 0-100% 0
VC
Board seat lead-VC lvcbos Representative from lead-VC on board: no (0), dummy 0/1 Questionnaire
yes (1)
239
EXPLANATORY VARIABLES - ABILITIES (Contd.)
Characteristics of lead-VC- lvccin Mean index of independent lead-VC-F, number ratio 0-1 Database
F index of portfolio companies, invested capital, age,
international activity index and reputation of lead
VC-F
Type of lead-VC-F lvctyp Type/affiliation of lead-VC firm: financial nominal 1-5 Database
institution (1), governmental investor (2),
corporate venture capitalist (3), independent
venture capitalist (4), other (5)
Independent lead-VC-F lvcind Affiliation of general parter of VC: non- dummy 0/1 Database
independent general partner (0), independent
general partner (1)
Number of portfolio lvcpcs Number of current portfolio companies: <20 (0), ratio 0-1 Database
companies lead-VC-F 20-99 (0,33), 100-499 (0,66), >=500 (1)
Invested capital VC-F lvccap Lead-VC firm's current total invested capital in ratio 0-1 Database
USD: <20 Mio. (0), 20-99,9 Mio. (0,33), 100-
499,9 Mio. (0,66), >= 500 Mio. (1)
Age of VC-F lvcage Lead-VC firm's current age in years: <= 5 years ordinal 1-3 Database
(1), 6-10 years (2), >10 years (3)
International activity of VC- lvcint Lead-VC firm's current international investment ordinal 1-4 Database
F: region activity by regions: regional investments (1),
national investments (2), European investments
(3), global investments (4)
Reputation of VC-F lvcrep Reputation of Lead-VC firm, analysed by means dummy 0/1 Database
of number of active participation in important VC
industry events (Super Investor, Super Return,
EVCA conference) and number of news articles
in important industry news services (AltaAssets,
Private Equity Week) since 2004: low reputation
(0), high reputation (1)
Abilities of VC-IM index aimind Mean index of Experience of VC investment ratio 0-1 Questionnaire
manager in VC industry, (portfolio company's)
industry, internationlly, start-up, number of
contacts per quarter and trustfullness of
relationship
Experience in VC industry imvcex Substantial experience of the investment dummy 0/1 Questionnaire
VC-IM manager of the lead-VC in the venture capital
industry (> 5 years): no (0), yes (1)
Industry experience VC-IM imidex Substantial experience of the investment dummy 0/1 Questionnaire
manager of the lead-VC in the industry of the
portfolio company: no (0), yes (1)
International experience VC- imitex Substantial international experience of the dummy 0/1 Questionnaire
IM investment manager of the lead-VC: no (0), yes
(1)
Startup experience VC-IM imsuex Substantial start-up experience of the dummy 0/1 Questionnaire
investment manager of the lead-VC: no (0), yes
(1)
Number of contacts per immeet Contact between the managers of the portfolio ratio 0-1 Questionnaire
quarter VC-IM company and the investment manager of the
lead-VC personally and by phone per quarter: 0
(0), 1-3 (0,33), 4-9 (0,66), >= 10 (1)
Number of portfolio imnpc Average number of PCs per employee of VC ratio >=0 Database
companies per employee of
VC
Trustfullness of relationship imtrus Trustfulness of relationship between the interval 1-5 Questionnaire
VC-M managers of the portfolio company and the
investment manager of the Lead-VC in the
opinion of the respondent: "--" (1), "-" (2), "o" (3),
"+" (4), "++" (5)
240
CONTROL VARIABLES
Development stage of pcfrde/c Development Status of portfolio company: ordinal 1-5 Questionnaire,
portfolio company dev seed(1), start-up (2), expansion (3), bridge (4), Database
MBO/MBI (5)
249 (3), >250 (4)
Europe (6)
Index of VC's influence on vciind Mean index of VC's influence on assessment of interval 0-1 Questionnaire
all CG elements managers, on selection of new managers, on
bonding of managers, on compensation of
managers on composition of board, on work of
board, on reporting discipline (all interval)
Annex 4: Variables related to hypotheses about venture capitalist's abilities
241
RESPONSE VARIABLES - FIRM VALUE
Impact of CG quality on cgper Impact of good corporate governance on interval 1-5 Questionnaire
firm performance portfolio company's performance in the opinion
of the respondent: "--" (1), "-" (2), "o" (3), "+"
(4), "++" (5)
Competitiveness relative to ccomc Competitiveness of the portfolio company interval 1-5 Questionnaire
direct and indirect o compared to its competitors in the opinion of
competitors the respondent: "--" (1), "-" (2), "o" (3), "+" (4),
"++" (5)
Performance according to cperpl Performance of the portfolio company interval 1-5 Questionnaire
plan according to the plan in the opinion of the
respondent: "--" (1), "-" (2), "o" (3), "+" (4),
"++" (5)
EBITDA-margin cpereb Average EBITDA/sales in percent ratio >=-100% Questionnaire
Net-profit-margin cpernp Average net profit/sales in percent ratio >=-100% Questionnaire
Return-on-equity cperre Average return/equity in percent ratio >=-100% Questionnaire
Return-on-assets cperra Average return/assets in percent ratio >=-100% Questionnaire
Growth in employees cgrem Average growth rate of number of employees in ratio >=-100% Questionnaire
percent
Growth in sales cgrsa Average growth rate of number of sales in ratio >=-100% Questionnaire
percent
Growth in cashflows cgrcf Average growth rate of number of cashflows in ratio >=-100% Questionnaire
%
Change of valuation cchval Change of valuation by investors between interval 1-5 Questionnaire
between financing rounds financing rounds: "--" (1), "-" (2), "o" (3), "+"
(4), "++" (5)
Change of sales multiple cchsal Change of sales multiple used for valuation ratio >=-100% Questionnaire
between financing rounds in percent
Change of cashflow cchcf Change of cashflow multiple used for valuation ratio >=-100% Questionnaire
multiple between financing rounds in percent
Change of EBITDA ccheb Change of EBITDA multiple used for valuation ratio >=-100% Questionnaire
multiple between financing rounds in percent
242
EXPLANATORY VARIABLES - SELF ASSESSMENT
EXPLANATORY VARIABLES - CRITERIA
CONTROL VARIABLES
Development stage of pcfrde/ Development Status of portfolio company: ordinal 1-5 Questionnaire,
portfolio company cdev seed(1), start-up (2), expansion (3), bridge (4), Database
MBO/MBI (5)
249 (3), >250 (4)
Europe (6)
Industry of portfolio pcindus Main industry of portfolio company: Hard- nominal 1-10 Database
company t /Software (1), Medical/Health (2),
Biotechnology (3), Communication (4), Other
Business/Consumer Services (5), Industrial
Goods/Energy (6),
Semiconductors/Electornics (7), Other (10)
Annex 5: Variables related to hypotheses about effects on firm value
243
t=0 - before the 1st financing round
Criteria
N Min Max Mean Std. Dev.
Agency and business risk index 138 44,6 89,3 68,3 9,9
CG quality index (self assessment) 139 18,8 93,8 59,4 14,5
CG quality index (criteria) 123 0,0 100,0 53,8 26,0
CG advice index (self assessment) 138 8,3 100,0 57,6 17,2
CG advice index (criteria) 125 0,0 100,0 43,9 31,4
Efficiency of selection of new managers 139 1,0 5,0 3,3 0,9
Index of quality of selection of managers 57 0,0 100,0 57,0 37,1
Efficiency of composition of board: advice 138 1,0 5,0 3,3 0,8
Index of quality of board composition 131 0,0 92,9 36,0 29,7
Efficiency of work of board: advice 138 1,0 5,0 3,3 1,0
Index of quality of work of board 135 0,0 100,0 37,7 26,4
Planned IPO 138 0,0 3,0 1,3 1,0
t=1 - after the 1st financing round

Criteria
Agency and business risk index - - - - -
Planned IPO 138 0,0 3,0 1,5 1,1
t=2 - after the 2nd financing round

Criteria
Agency and business risk index - - - - -
Planned IPO 73 0,0 3,0 1,4 1,1
t=3 - after the 3rd financing round

Criteria
Agency and business risk index 138 25,0 88,1 70,8 9,3
Planned IPO 30 0,0 3,0 1,4 1,1
Annex 6: Descriptive analysis of variables related to venture capitalists' reasons
244
Criteria
Index of abilities 134 6,5 100,0 61,1 19,0
Control rights of lead-VC-F index 137 0,0 100,0 61,5 28,0
Ownership rights of lead-VC 112 2,4 100,0 38,0 24,8
Board seat lead-VC 137 0,0 1,0 0,8 0,4
Characteristics of lead-VC-F index 139 2,8 100,0 53,2 28,0
Type of lead-VC-F 139 1,0 5,0 3,4 1,2
Independent lead-VC-F 138 0,0 1,0 0,7 0,5
Number of portfolio companies lead-VC-F 130 0,0 1.260,0 185,1 375,5
Invested capital VC-F 128 0,0 14.000,0 1.312,2 2.718,7
Age of VC-F 134 1,0 3,0 2,4 0,7
International activity of VC-F: region 139 1,0 4,0 3,2 1,0
Reputation of VC-F 139 0,0 1,0 0,3 0,4
Abilities of VC-IM index 136 0,0 100,0 69,0 24,2
Experience in VC industry VC-IM 134 0,0 1,0 0,8 0,4
Industry experience VC-IM 136 0,0 1,0 0,6 0,5
International experience VC-IM 129 0,0 1,0 0,7 0,5
Startup experience VC-IM 122 0,0 1,0 0,7 0,5
Number of contacts per quarter VC-IM 131 1,0 150,0 11,1 15,9
Trustfullness of relationship VC-M 137 1,0 5,0 4,4 0,9

Criteria
Type of lead-VC-F 73 1,0 4,0 3,5 1,1
Age of VC-F 69 1,0 3,0 2,4 0,7
Number of contacts per quarter VC-IM 68 -0,1 14,0 3,1 2,8
245
Criteria
Type of lead-VC-F 28 1,0 4,0 3,6 1,0
Number of portfolio companies lead-VC-F 27 0,0 735,0 122,1 213,6
Invested capital VC-F 27 0,0 14.000,0 778,4 2.657,6
Age of VC-F 27 1,0 3,0 2,4 0,6
Annex 7: Descriptive analysis of variables related to venture capitalists' influence on corporate

governance
246
Criteria
CG quality index (self-assessment) 139 18,8 93,8 59,4 14,5
CG monitoring index (self-assessment) 138 12,5 100,0 57,9 16,3
CG monitoring index (criteria) 133 0,0 85,9 44,8 19,9
CG bonding index (self-assessment) 136 0,0 100,0 64,8 21,8
CG bonding index (criteria) 118 12,5 95,8 50,7 19,0
CG advice index (self-assessment) 138 8,3 100,0 57,6 17,2
Efficiency of assessment and selection of managers 139 0,0 100,0 58,6 18,5
Efficiency of assessment of managers 139 1,0 5,0 3,4 0,9
Replacements of managers per financing round 83 0,0 3,0 0,3 0,7
Efficiency of bonding of managers 137 1,0 5,0 3,8 1,1
Index of quality of bonding of managers 118 0,0 100,0 60,7 26,7
Efficiency of compensation of managers 136 1,0 5,0 3,4 1,1
Index of quality of compensation of managers 127 0,0 93,8 41,7 24,2
Level of compensation compared to industry 131 1,0 5,0 2,7 1,1
Efficiency of composition of board: monitoring 138 1,0 5,0 3,1 0,8
Proportion of independent board members 116 0,0 1,0 0,1 0,2
Industry experience of independent board members 123 0,0 8,0 1,0 1,5
Executive experience of independent board members 122 0,0 9,0 1,4 1,7
International experience of independent board members 97 0,0 5,0 1,0 1,3
Functional experience of independent board members 122 0,0 9,0 0,9 1,3
Startup experience of independent board members 114 0,0 4,0 0,7 1,0
Experience as managers or board member in listed
companies of independent board members 124 0,0 1,0 0,3 0,5
Efficiency of work of board: monitoring 138 1,0 5,0 3,2 0,9
Number of board meetings per year 136 0,0 25,0 4,8 4,2
Distribution of agenda and relevant information 115 2,0 5,0 4,0 1,0
Proportion of time devoted to strategic issues 132 0,0 100,0 25,5 23,9
Efficiency of reporting discipline 138 1,0 5,0 3,5 1,0
Index of quality of reporting discipline 127 6,5 100,0 60,8 22,9
Number of reports per year 130 0,0 16,0 3,5 4,5
Timeliness of reporting 128 1,0 5,0 3,4 1,2
Extent of target-actual differences 117 1,0 4,0 2,5 1,0
Number of board members 128 0,0 10,0 3,3 2,1
Proportion of time devoted to monitoring issues 132 0,0 85,0 17,0 16,6
Proportion of Time devoted to Operational Issues 132 0,0 100,0 36,9 29,2
One tier: proportion of non-executive board members 89 0,0 1,0 0,3 0,3
Conduct of assessment of managers 108 0,0 1,0 0,6 0,5
Importance of annual bonus versus variable compensation
linked to mid-/long-term development 108 1,0 3,0 1,6 0,8
Managers with variable compensation linked to mid-/long-term
development 111 0,0 1,0 0,2 0,4
247
Criteria
Experience as managers or board member in listed companies
of independent board members 25 0,0 1,0 0,8 0,4
development 27 0,0 1,0 0,3 0,4
248
Criteria
Mean Std. Dev. N Mean Max
development 0 0,4 129,0 0,0 1,0
249
Criteria
development 27 0,0 1,0 0,3 0,4
Annex 8: Descriptive analysis of variables related to the quality of corporate governance
250
Criteria
Type of lead-VC-F 139 1,0 5,0 3,4 1,2
Age of VC-F 134 1,0 3,0 2,4 0,7

Criteria
Type of lead-VC-F 73 1,0 4,0 3,5 1,1
Age of VC-F 69 1,0 3,0 2,4 0,7
Number of contacts per quarter VC-IM 68 -0,1 14,0 3,1 2,8
251
Criteria
Type of lead-VC-F 28 1,0 4,0 3,6 1,0
Number of portfolio companies lead-VC-F 27 0,0 735,0 122,1 213,6
Invested capital VC-F 27 0,0 14.000,0 778,4 2.657,6
Age of VC-F 27 1,0 3,0 2,4 0,6
Annex 9: Descriptive analysis of variables related to the venture capitalists' abilities
252
Criteria
Competitiveness relative to direct and indirect
competitors 127 1,0 5,0 3,5 1,0
Performance according to plan 125 1,0 5,0 3,2 1,2
EBITDA-margin 65 -25,0 40,0 7,6 11,5
Net-profit-margin 57 -25,0 75,0 4,9 11,9
Return-on-equity 52 -25,0 300,0 15,0 44,8
Return-on-assets 48 -25,0 100,0 8,3 18,0
Growth in employees 102 -30,0 500,0 27,3 64,2
Growth in sales 100 -10,0 2.000,0 41,7 201,1
Change of valuation between financing rounds - - - - -
Change of sales multiple - - - - -
Change of EBITDA multiple - - - - -

Criteria
competitors 131 1,0 5,0 3,9 0,8
EBITDA-margin 65 -50,0 50,0 7,4 17,3
Return-on-equity 52 -25,0 100,0 11,7 19,3
Return-on-assets 47 -25,0 100,0 10,3 18,3
Growth in employees 109 -50,0 2.000,0 94,5 266,3
Growth in sales 104 -40,0 1.000,0 46,6 116,6
Change of valuation between financing rounds 65 1,0 5,0 3,7 1,0
Change of sales multiple 27 -58,0 1.000,0 83,3 215,0
Change of EBITDA multiple 18 -25,0 200,0 19,9 53,9

Criteria
competitors 68 1,0 5,0 4,1 0,8
EBITDA-margin 26 -50,0 40,0 3,2 17,9
Return-on-equity 22 -25,0 100,0 7,1 23,9
Return-on-assets 20 -25,0 100,0 5,5 23,5
Growth in sales 49 0,0 1.000,0 88,1 184,8
Change of valuation between financing rounds 27 2,0 5,0 3,0 0,9
Change of sales multiple 9 -30,0 300,0 28,9 102,2
Change of EBITDA multiple 7 -30,0 0,0 -4,3 11,3

Criteria
competitors 28 1,0 4,0 3,9 0,8
EBITDA-margin 6 -50,0 20,0 -4,3 27,8
Net-profit-margin 6 -50,0 20,0 -5,3 27,2
Return-on-equity 5 -25,0 20,0 -4,6 20,0
Return-on-assets 4 -25,0 50,0 7,0 31,3
Growth in sales 18 0,0 100,0 43,9 47,6
Change of valuation between financing rounds - - - - -
Change of sales multiple - - - - -
Change of EBITDA multiple - - - - -
Annex 10: Descriptive analysis of variables related to the portfolio companies' firm value
253
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Maik Kleinschmidt

Venture Capital, Corporate Governance, and Firm Value

With a foreword by Prof. Dr. Alexander Bassen

Dissertation Universität Hamburg, 2006

1. Auflage März 2007

Das Werk einschließlich aller seiner Teile ist urheberrechtlich geschützt.

Die Wiedergabe von Gebrauchsnamen, Handelsnamen, Warenbezeichnungen usw. in diesem

Prof. Dr. Alexander Bassen

2 Foundations of Venture Capital and Corporate Governance_____________ 17

5 Empirical Analyses ______________________________________________ 119

6 Conclusion _____________________________________________________ 199

1.1 Relevance of the Topic

The particular corporate governance — i.e., the framework of management and

The importance of venture capital-financed companies to the European economy is

1.2 Literature Review

1.2.1 Foundations of Research on Venture Capital and Corporate

BERLE/MEANS6 first defined corporate governance in 1932 against the background

Recently, research appeared that focused on the advice function of corporate

1.2.2 Venture Capitalists' Influence on Corporate Governance

The work of SAPIENZA ET AL. compares venture capitalists’ influence on corporate

Important work on investment contracts was done by, among others,

1.2.3 Effects of Venture Capitalists' Influence on Corporate

ROSENSTEIN38 analysed the effects of venture capitalists on the balance of power in

1.2.3.3 Reporting Discipline

These findings indicate that venture capitalists influence portfolio companies to

1.2.4 Effects of Corporate Governance on Firm Value

1.3 Aims of the Research

1.4 Research Approach

The design of this research is characterised mainly by four particularities. First, it

1.5 Structure of the Research

Conclusion Summary of results Discussion Outlook

Figure 1: Structure of the thesis

2.1 Introduction of Venture Capital

Generally, venture capital is an equity or equity-related financing form for growth

Venture capital is an equity or equity-related financing form for private growth

 Equity or equity-related financing

 Concentration on growth companies

Cooperation with the

Figure 2: Influence of venture capitalists on portfolio companies

2.1.3 The Venture Capital Value Chain

Venture capitalists Fundraising Investment Exit

Portfolio companies Start-up Growth Newly quoted

Figure 3: Venture capital value chain78

There are five groups of investors to distinguish:

Figure 4: Newly invested capital in Europe 2005 by investor type90

2.1.3.2 Deal Sourcing and Screening

Early Stage Expansion Stage Late Stage

Seed Start-up Expansion Bridge MBO/MBI

Development • Formation of a • Formation of a • Start of • Preparation of • Take-over by

Typical financial Own funds Debt financing

Figure 5: Development phases of growth companies96

 Competence and experience of the managers

 Personality of the managers

 Characteristics of the market

 Characteristics of the product

2.1.3.4 Venture Management

One important element of venture management at portfolio companies is the

 Trade Sale: Sale of the shares to a strategic investor, generally an industrial

2.1.4 Development Status of the Venture Capital Industry

2.1.4.1 Emergence of the Industry

2.1.4.2 Development of Investments

Figure 6: Volume of funds raised and investments in Europe 1995–2005121

Figure 7: Funds raised by type of venture capitalist in Europe 2001–2005122

Equity or equity-related financing

Concentration on growth companies

Competence and experience of the managers

Personality of the managers

Characteristics of the market

Characteristics of the product

Trade Sale: Sale of the shares to a strategic investor, generally an industrial

Reporting and auditing

Monitoring the company’s development and management’s actions can prevent

Market for corporate control

Managerial risk aversion: Managers and shareholders of a company might bear

A comparatively great part of the companies’ assets is intangible or difficult to

The characteristic of managerial ownership of growth companies can strengthen

Growth companies normally operate in highly dynamic environments. To

Valuable: Growth companies often operate in highly dynamic markets.281 In such

Rare: To confer a competitive advantage, good corporate governance must be rare

Imperfectly imitable/substitutable: In highly dynamic markets, dynamic