Essays in financial economics

Abstract

This dissertation studies how financing shapes innovative entrepreneurship, and how promotions interact with the organization of knowledge in production. The first chapter examines how venture capital affects entrepreneurial innovation in a multi-sector occupational choice model. Agents choose to work or to become entrepreneurs depending on labor market and venture capital financing conditions. A larger venture capital sector incentivizes entrepreneurship, but at the cost of fewer talented workers in the economy and higher wages that limit innovation. When a sector becomes more productive, demand for venture capital increases, raising monitoring costs across the economy. I finally show that distortions to R&D create spillovers through the market for venture capital. Competition for a shared pool of excludable ideas leads to excessive demand for venture capital, increasing monitoring costs for entrepreneurs and lowering innovation across all sectors. The second chapter develops a model of early-stage financing in which entrepreneurs overcome uncertainty through experimentation and investors differ in scale, staging ability, and advising capability. The model shows that when investor advice and entrepreneurial effort reinforce each other by encouraging entrepreneurs to take on more risk, active investors back the most difficult ideas. When effort and advice substitute each other, investors shift to safer projects. The model helps explain the coexistence of diverse investors, the move of venture capital toward later stages, and the lack of active investors in “tough tech” sectors. The third chapter studies how promotions interact with the organization of knowledge in production. Firms organize hierarchically when managers’ expertise supports multiple workers, but prestige-driven promotion contests can distort production by diverting talent into inefficient lotteries, undermining knowledge complementarities between workers and managers across the economy. When promotion contests generate efficiency gains through, for instance, incentive effects, prestige can be socially valuable, especially in sectors with high communication costs.