Venture Capital Finance – Eliminating Double Sided Moral Hazards Through Trade-off Between Economic and Behavioural Economic Aspects – A Case Analysis

Abstract

Venture capital finance has two aspects, the economic aspect and the behavioural economic aspect. The economic aspect includes issues such as conflict of interest between the entrepreneur and the venture capitalist (VC), asymmetric information, moral hazard, and compensation issues for both the parties. The behavioural economic aspect is related to relational factors such as empathy and a feeling of fairness and trust shown by both the parties.Therefore, while deciding the financer, entrepreneur should consider both relation aspect and value add services of the financier and strike optimal trade-off. The ensuing case analysis has been carried out focusing on elimination of double sided moral hazards through a proper trade-off between economy and behavioural economic theories (aspects).The performance of the venture can be enhanced by balancing both of these theories in practice. An equity distribution that represents economic reward is a source of motivation for both the parties to put optimal efforts towards the success of the venture. This was seen in the case analysis, when the parties perceived the initial equity distribution agreement as fair, the satisfaction level of all the parties increased, leading to the reduction in the possibility of double-sided moral hazard and ensuring the success of the venture. Moreover, the analysis shows that information sharing and two-way communication increases trust and improves decision quality. It further focusses on how feedback and proper work distribution results in efficiency of performance for each of the stakeholders, leading to reduced probability of double-sided moral hazards.