Optimal allocation of control rights based on various financing contracts: A dynamic perspective

Abstract

This research is focused on the dynamic allocation of control rights between entrepreneurs and venture capitalists. The paper proceed to study by explicitly introducing a continuous variable of control rights, the different financing contracts and the cost function into the model of venture capital backed start-ups which was set up by Tirole in 2001, investigating main factors which influenced the efficient allocation of control rights under the different financing tools. The paper address the main ideas as follow: (i) The entrepreneur's individual rationality constraint and incentive compatibility constraint are different from those of venture capitalist. (ii)The main factors which affect the dynamic allocation of control rights are the effort of entrepreneurs, reputation of entrepreneurs and non-pecuniary control benefit. (iii)The combination of convertible securities and the dynamic allocation of control rights is the optimal way that could efficiently allocate the control rights between entrepreneurs and venture capitalists.