Optimal exit decision of venture capital under time-inconsistent preferences

TL;DR

This paper models how different types of venture capitalists with time-inconsistent preferences decide optimal exit timing, revealing they tend to exit earlier than consistent ones and that their delay behavior varies with expiration length.

Contribution

It introduces a novel model analyzing four types of venture capitalists with distinct time-inconsistent preferences and compares their optimal exit thresholds.

Findings

All time-inconsistent VCs tend to exit earlier than time-consistent VCs.

Longer expiration dates lead to delayed exits, with the delay degree varying among VC types.

Sophisticated VCs understand their time-inconsistency and delay less than naive VCs.

Abstract

This paper proposes two kinds of time-inconsistent preferences (i.e. time flow inconsistency and critical time point inconsistency) to further advance the research on the exit decision of venture capital. Time-inconsistent preference, different from time-consistent preference, assumes that decision makers prefer recent returns rather than future returns. Based on venture capitalists' understanding of future preferences, we consider four types of venture capitalists, namely time-consistent venture capitalists, venture capitalists who only realize critical time point inconsistency, naive venture capitalists and sophisticated venture capitalists, of which the latter three are time-inconsistent. All types of time-inconsistent venture capitalists are aware of critical time point inconsistency. Naive venture capitalists misunderstand time flow inconsistency while sophisticated ones understand it correctly. We propose an optimal exit timing of venture capital model. Then we derive and compare the above four types of venture capitalists' exit thresholds. The main results are as follows: (1) all types of time-inconsistent venture capitalists tend to exit earlier than time-consistent venture capitalists. (2) The longer the expire date are, the more likely venture capitalists are to delay the exit, but the delay degree decreases successively (venture capitalists who only realize critical time point inconsistency > naive venture capitalists > sophisticated venture capitalists).