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Countermeasures and research on adverse selection of venture capital under asymmetric information

Author(s): Ling Zhang1,* , Yi Cui1, Mian-Bin Zheng2, Yao Xiao1

Adverse selection between venture capitalists and entrepreneurs may lead to inefficiency of investment. Sometimes it may be make the investment fail. The purpose of this study is to eliminate or reduce the negative impact of adverse selection on investment decisions, so as to improve the decision-making efficiency. This study describes the adverse selection between venture capitalists and entrepreneurs in the process of projects selection, analyzes the impact of venture capitalists’ contract design and venture entrepreneurs’ signal mechanism on adverse selection. By introducing stock proportion of venture capital into the contract design between venture capitalists and entrepreneurs, we construct an equilibrium model and enrich the signaling theory in venture capital circumstances. Analysis shows that the decision whether a venture capitalist and an entrepreneur can reach an investment agreement or not is determined by the total expected return and stock proportionate of entrepreneurs. Reasonable stock proportionate, sufficient total expected revenue, reduction of adverse selection cost can all reduce the phenomenon of adverse selection under asymmetric information.

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