ANTI-COMPETITIVE FINANCIAL CONTRACTING: THE DESIGN OF FINANCIAL CLAIMS.



argued that such a trade-off was indeed at the centre of the industrial revolu-
tion in Germany and elsewhere. A concise description of the role of large equity
holding banks in Belgian, German and Italian industrialization can be found
in Da Rin and Hellman (1998). It is clear that by holding equity, these banks
(in contrast to the debt-holding British banks of the time, for example), had a
very active interest in the profitability of the firms they funded. They limited
product-market competition, but the monopoly profits made thus available
were ploughed back into the business to produce very fast expansion. But
as growth has slowed down in Germany in the last three decades, there has
been more concern about the large stakes controlled by the banking system,
and the banks have been the subject of several competitive investigations.22 A
more recent concern is that the German economy has not developed the small
dynamic firms in information and bio-technology that have developed in the
US and UK; to the extent that these industries exist in Germany, it is only
as divisions of incumbent firms. Thus one might well worry that the universal
banking system is beginning to stifle growth.

6.2 Convertible debt and the Venture Capitalist’s Coase
problem

6.2.1 Introduction

As mentioned above, the Coase problem may be particularly acute in emerging
industries. In the US, such new industries are often financed by venture capital.
Recent evidence (Gompers and Lerner 2000) suggests that, at least at times
when the supply of funds to venture capital is tight, venture capitalists do have
a degree of market power in financing entrepreneurs.23 This is not surprising
since the number of venture capitalists that an entrepreneur might approach for
funding is often fairly limited: he must choose one which is locally-based and
has specialized knowledge of the industry in which he will operate. The fact
that venture capitalists invariably club together to form syndicates in financing
firms further increases their monopoly power. Indeed, reading descriptions of
the bargaining process between venture capitalist and entrepreneur, one has
the impression that a substantial amount of bargaining power lies with the

22 Note that the current German situation differs somewhat from our model in that the
proxy voting system allows the banks to control a much larger fraction of shares than they
actually own.

23 Gompers and Lerner (2000) show that the price which venture capitalists pay en-
trepreneurs for shares in their firms rises when the supply of venture capital increases,
and that this is not due to changes in firm characteristics, but rather to “money chasing
deals” and venture capitalists competing to fund projects. The converse of this, of course, is
that at times when the supply of funds is tight, then competition to fund projects is limited,
and venture capitalists can exploit monopoly power in bargaining with entrepreneurs.

21



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