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77 Chi.-Kent L. Rev. 211


This Article examines the question of why venture capital firms would continue to raise technology funds, and then invest those funds, when they were certain that the business markets for such investments were overvalued preceding the “crash” of April 2000. We interviewed a number of venture capitalists, lawyers, entrepreneurs, and other industry observers in search of an explanation. The explanations offered by key decision makers for the observed investment behavior can be categorized as of three types of theories: agency cost theories, herd behavior and other cognitive bias theories, and non–agency cost theories. Agency cost theories suggest that the activity took place because of the divergence between the long-term reputational and other interests of fund general partners (venture capital firms), and the short-term interests of their limited partner investors. Herd behavior explanations apply herding theory to the general movement of venture capital firms, but fail to provide a satisfactory explanation for the direction of the “herd.” Non-agency cost theories include explanations premised upon gaming strategies by better-informed venture capitalists in the context of less-informed public markets at the end of the investment pipeline. All of the theories surveyed are problematic in at least some respects, and none fully explains the pattern of investment observed.



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