UC Berkeley

This thesis explores the roles of two significant financial intermediaries in the financial markets: venture capital firms, which facilitate equity financing, and banks, which provide debt financing. Initially, the thesis concentrates on the entrepreneurial financing market, examining the factors that influence venture capital firms' decision-making processes when selecting investments. Subsequently, as a complement to equity financing for startups, the thesis delves deeper into the role of banks in offering venture debt. Recognizing that deposits serve as the foundational basis for banks to issue debt, the final part of the thesis investigates competition in the deposit market and the methods banks employ to determine deposit rates.

Venture capital plays a critical role in entrepreneurial finance, with networks prominently featuring in venture capital (VC) markets. Chapter 1, \textbf{Networks in Venture Capital Markets}, explores the role and channels of networks in VC investments. The paper examines alumni networks between VCs and startups, using a new partner with new alumni networks joining a venture capital company as a plausibly exogenous shock to the VCs' alumni networks to identify the network effects on VC investments. New alumni ties lead to a significant increase in investments in startups with alumni founders. However, startups with new alumni ties perform worse, with higher failure rates and lower acquisition rates, IPO rates, and portfolio returns. This highlights VCs' overemphasis on alumni networks and potential inefficiencies in their investment strategies. To understand the underlying mechanism, the paper frames network effects through two channels: improving information (information channel) and inducing homophily-based favoritism (preference channel). Supplementary tests suggest that the preference channel outweighs the information channel, leading to VCs' capital misallocation.

As a complementary financing option to equity financing for startups, Chapter 2, \textbf{Signaling in the Venture Debt Financing}, sheds light on the interaction between startup financing and banks. Venture debt financing for startups has experienced steady growth in recent years, prompting this paper to focus on understanding the rise of venture debt through a signaling channel. We model and document the role of venture debt as a positive signal in startup financing under asymmetric information, which increases the probability of a firm receiving future venture capital (VC) funding, thereby reducing the risk of venture debt and encouraging lending to startups. However, VCs' reliance on this signal induces over-investment in lower-quality startups, as they interpret venture debt as a positive signal and conduct less thorough due diligence. Data show that startups invested after obtaining venture debt perform worse than others. This paper offers a unique explanation for the rise of venture debt and highlights the efficiency loss induced by venture debt.

Chapter 3, \textbf{Banks' Rate Setting Behavior and Regional Distribution of Deposit Rates}, turns to the competition in the deposit market, documenting banks' differential deposit rate-setting behavior associated with bank size. Large banks set uniform deposit rates that ignore local market competition, while small banks set higher rates and respond to local market conditions. Despite large banks setting lower deposit rates, they hold the majority of deposits. We find that the differential rate setting behavior is due to customer segmentation between large and small banks. Large banks target more populated areas with higher-income populations who value complex financial services and are less sensitive to low deposit rates. In contrast, small banks serve rural regions where customers prioritize deposits and are more sensitive to deposit rates.