Fairness Norms and Self-Interest in Venture Capital/Entrepreneur Contracting and Performance

Abstract

We consider the combined impact of agency problems and social fairness norms on venture capital/entrepreneur contracting and performance. Particularly, we develop a behavioural game-theoretic model in which a venture capitalist and an entrepreneur negotiate over their respective equity shares, and then exert value-adding efforts in running the business. Double-sided moral hazard exists in that both parties may exert sub-optimal effort (the ‘shirking’ problem). We demonstrate that, for a given level of VC-ability, an increase in social fairness norms induces the VC to offer more equity to the entrepreneur, which in turn induces the entrepreneur to exert more effort. This improves venture performance.