Abstract

Why don't successful venture capitalists eliminate excess demand for their follow-on funds by

aggressively raising their fees? We propose and test a theory of learning that leads to informational

hold-up in the VC market. Investors in a fund learn whether the VC has skill or was lucky, whereas

potential outside investors only observe returns. This gives the VC's current investors hold-up

power when the VC raises his next fund: Without their backing, he cannot persuade anyone else

to fund him, since outside investors would interpret the lack of backing as a sign that his skill

is low. This hold-up power diminishes the VC's ability to increase fees in line with performance.

The model provides a rationale for the persistence in after-fee returns documented by Kaplan and

Schoar (2005) and predicts low expected returns among rst-time funds, persistence in investors

from fund to fund, and over-subscription in follow-on funds raised by successful VCs. Our empirical

evidence from a large sample of U.S. VC funds raised between 1980 and 2006 is consistent with