Financing breakthroughs under failure risk

Simon Mayer

Journal of Financial Economics, 2022, vol. 144, issue 3, 807-848

Abstract: In a dynamic principal-agent model, the principal, financing the project, cannot observe project failure and the agent, developing the project, can hide failure. As there is a tension between incentives for disclosure of failure and project development, the optimal contract does not reward failure and incentivize disclosure of failure during an initial unconditional financing stage. During the subsequent disclosure stage, time-decreasing rewards for failure provide incentives for disclosure of failure. The continuation of financing becomes more performance-sensitive across stages, and the agent’s incentives are backloaded. The model explains several empirical patterns in venture capital financing and the financing of innovation.

Keywords: Innovation; Venture capital; Agency conflicts; Adverse selection; Dynamic contracting (search for similar items in EconPapers)
JEL-codes: G0 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:144:y:2022:i:3:p:807-848

DOI: 10.1016/j.jfineco.2022.01.005

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