Abstract
This article aims to use a bargaining power model to reduce moral hazard—in the form of entrepreneurial effort shirking—and derive an optimum sharing ratio of a Profit and Loss Sharing (PLS) contract that involves a Venture Capitalist and an Entrepreneur. The model reveals the following interesting findings. First, under complete information—where the Venture Capitalist has a bargaining power - Venture Capitalist offers the entrepreneur a profit sharing ratio that is less than her capital contribution ratio. Second, in an incomplete information setting, the entrepreneur demands a profit sharing ratio higher than her capital contribution ratio when the sum of the marginal cost (from exercising a higher effort) and private benefits (from exercising a low effort) is greater than the marginal return (from exercising a high effort). In addition, the model is used to derive a span of negotiation about the profit sharing ratio. Finally, an agent based simulation (Netlogo) platform is considered to implement the model, which allows a faster numerical calculations of the profit share and helps decide on the validity of the funding contract.
Original language | English |
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Journal | International Journal of Finance and Economics |
Early online date | 24 Jan 2021 |
DOIs | |
Publication status | E-pub ahead of print - 24 Jan 2021 |
Keywords
- agent-based simulation (Netlogo)
- finance
- moral hazards
- optimal profit-sharing
- profit and loss sharing contracts
ASJC Scopus subject areas
- Accounting
- Finance
- Economics and Econometrics