The complementarity effect: Effort and sharing in the entrepreneur and venture capital contract

Marcos Vergara, Claudio Bonilla and Jean Sepulveda ()

European Journal of Operational Research, 2016, vol. 254, issue 3, 1017-1025

Abstract: This paper focuses on the relationship between the venture capitalist and the entrepreneur. In particular, it analyses how both players’ unobservable effort levels affect the equity share that the entrepreneur is willing to cede to the venture capitalist. We solve the entrepreneur’s maximization problem in the presence of double-sided moral hazard. In this scenario, we show that the venture capitalist’s share is binding and, therefore, there is no efficiency wage. We simulate the model and show that the entrepreneur’s effort does not monotonically decrease in the share allocated to the venture capital, while the venture capitalist’s effort does not monotonically increase in his share. We show that as efforts tend to be more complementary, the project cash flows are distributed nearly equally, at approximately 50% for each partner. This theoretical finding is actually observed in real contracts between entrepreneurs and venture capitalists.

Keywords: Double-sided moral hazard; Venture capital; Equity share (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (10)

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Working Paper: The Complementarity Effect: Effort and Sharing in the Entrepreneur and Venture Capital Contract (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:254:y:2016:i:3:p:1017-1025

DOI: 10.1016/j.ejor.2016.04.040

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