Divestment, entrepreneurial incentives and the life cycle of the firm

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6 Citations (Scopus)


An entrepreneur who wants to divest his firm suffers a time-inconsistency problem: divesting a stake creates an incentive to divest further since he does not internalize the arising agency costs for the stake already sold. This paper shows that this leads to excessive divestment in equilibrium and entails efficiency losses which can offset any potential divestment gains. As a result, firms may stay private even if there are large gains from going public. We show that venture capitalists can reduce these inefficiencies. This is because they have influence over a firm's divestment decisions and can distinguish between an excessive and a desirable dilution of equity (such as in response to liquidity shocks). We also show that the divestment inefficiency gives rise to an optimal time of going public, which trades off the gains from going public early (higher divestment gains) with its costs (higher divestment inefficiency).
Original languageEnglish
Pages (from-to)591-611
Number of pages21
JournalJournal of Business Finance and Accounting
Issue number5-6
Publication statusPublished - 2010
Externally publishedYes

Bibliographical note

Appeared earlier as CentER DP 2002-47(rt)


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