Investment stage drifts and venture capital managerial incentives

Article history: Received 22 January 2014 Received in revised form 25 May 2015 Accepted 26 May 2015 Available online 29 May 2015 This paper investigates VC investment stage drifts as explained by the outcomes of managerial incentive schemes under different financial market conditions and past return performances. We exploit a unique dataset containing data for all of the venture capital funds in Europe that received financial support from the European Investment Fund (EIF) during the years 1998–2007. The dataset includes 149 VC funds that invested in 1925 companies. We find that a higher hurdle rate produces a compensation incentive that discourages VC managers from lowering funds' risk. We also observe that more reputable fund managers are less likely to increase risk by downward stage drifting and more likely to play it safe by following upward stage drifting strategies. Finally, managers of funds with a poor past performance appear to be less keen to perform stage drifts towards less risky stages, relative to well-performing fund managers. The latter evidence is more significant in periods of bull financial markets. © 2015 Elsevier B.V. All rights reserved. JEL classification: G24 L14 M52