Fixed versus dynamic investment: Optimal contracting with competitive entrepreneurs

Liyuan Wang, Chuan Ding, Zhiyu Wang and Siyuan Zeng

Finance Research Letters, 2025, vol. 82, issue C

Abstract: This study explores dynamic contracting in venture capital investment, where entrepreneurial compensation integrates absolute and relative performance. We identify a paradox in investment strategies based on startup efficiency: fixed capital suits efficient startups, while dynamic investment benefits inefficient ones. If the Venture Capitalist (VC) can switch strategies, starting with dynamic early-stage investment and transitioning to fixed allocation would enhance returns. We also examine the trade-off between equity and competition incentives, showing that competition incentives strengthen under high correlation and uncertainty, diverging from standard agency theory. These insights help balance effort, incentives and optimize VC financing strategies.

Keywords: Venture capital; Dynamic contracts; Entrepreneurial incentives; Dynamic capital allocation; Performance-based competition; Heterogeneity (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:82:y:2025:i:c:s1544612325007548

DOI: 10.1016/j.frl.2025.107495

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