The Effects of Self-interest and Fairness on Entrepreneur/Venture Capitalist Financial Contracting and Performance

Abstract

I consider the effects of entrepreneurial inequity-aversion on financial contracting with a self-interested venture capitalist, in a single-sided and double-sided moral hazard setting. In the pure principal-agent model, as the proportion of self-interested entrepreneurs in the population increases, the venture capitalist's optimal equity offer to the entrepreneur decreases, and the entrepreneur reduces effort. Welfare is maximized when there is a mix of self-interested and inequity averse entrepreneurs in the population. In the double-sided moral hazard setting, the first-best level of welfare is achieved when an inequity-averse entrepreneur matches with a self-interested value-adding venture capitalist, and the threat from ex post opportunism is low.