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Double-sided moral hazard, information screening and the optimal contract

Double-sided moral hazard, information screening and the optimal contract PurposeIn the practice of venture capital investment, the venture capital will not only claim the share of the enterprise’s future output, but also a certain amount of fixed income. The purpose of this paper is to examine the optimal contract which blends the variable ownership income and the fixed income theoretically so as to provide a keen insight into the venture capital practice.Design/methodology/approachThis paper establishes an extended principal-agent model and researches on the design of optimal contract dominated by venture capital with double-sided moral hazard and information screening.FindingsBy establishing theoretical models, the main findings are: first, high-quality enterprise tends to relinquish less ownership but give more fixed return to the venture capital as compensation in order to obtain the venture capital financing; second, low-quality enterprise is willing to relinquish more ownership but give less fixed return to the venture capital for financing; third, due to the existence of double-sided moral hazard, neither of the venture capital and the enterprise will exert their best effort.Originality/valueThis paper furthers the application of principal-agent model in the field of venture capital investment and researches on the optimal contract, considering double-sided moral hazard and adverse selection at the same time originally. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png China Finance Reviewinternational Emerald Publishing

Double-sided moral hazard, information screening and the optimal contract

Xue, Jin; Fei, Yiwen
China Finance Reviewinternational , Volume 6 (4): 28 – Nov 21, 2016
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28 pages

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Publisher
Emerald Publishing
Copyright
Copyright © Emerald Group Publishing Limited
ISSN
2044-1398
DOI
10.1108/CFRI-04-2016-0015
Publisher site
See Article on Publisher Site

Abstract

PurposeIn the practice of venture capital investment, the venture capital will not only claim the share of the enterprise’s future output, but also a certain amount of fixed income. The purpose of this paper is to examine the optimal contract which blends the variable ownership income and the fixed income theoretically so as to provide a keen insight into the venture capital practice.Design/methodology/approachThis paper establishes an extended principal-agent model and researches on the design of optimal contract dominated by venture capital with double-sided moral hazard and information screening.FindingsBy establishing theoretical models, the main findings are: first, high-quality enterprise tends to relinquish less ownership but give more fixed return to the venture capital as compensation in order to obtain the venture capital financing; second, low-quality enterprise is willing to relinquish more ownership but give less fixed return to the venture capital for financing; third, due to the existence of double-sided moral hazard, neither of the venture capital and the enterprise will exert their best effort.Originality/valueThis paper furthers the application of principal-agent model in the field of venture capital investment and researches on the optimal contract, considering double-sided moral hazard and adverse selection at the same time originally.

Journal

China Finance Reviewinternational – Emerald Publishing

Published: Nov 21, 2016

References

  • Study on allocation model of control rights in venture firms
  • A control theory of venture capital finance
  • Double-sided moral hazard and the nature of share contracts
  • Double-side incentive problem and the equity structure of venture firm