Contractual Execution, Strategic Incompleteness and Venture Capital

Contractual execution generates hard information, available to the contracting parties, even when contracts are secretly executed. Building on this simple observation, the paper shows that incomplete contracts can be preferred to complete contracts. This is because (i) execution of incomplete contracts reveals less information to outside parties, giving rise to strategic gains; (ii) secretly executed complete contracts could not do better, given the possible strategic uses of the hard information generated by execution of the contract. The key effects at work are explored in the case of financial contracts for innovative start-up companies, providing a rationale for the observed differences in the extent to which venture capital contracts include a variety of contingencies, and for how this varies across industries and geographically.

Work for Image and Work for Pay

Standard economic models with complete information predict a positive, monotonic relationship between pay and performance. This prediction does not always hold in experimental tests: offering a small payment may result in lower performance than not offering any payment. We test experimentally two main explanations that have been put forward for this result: the "incomplete contract" hypothesis views the payment rule as a signal given to subjects on purpose of the activity. The "informed principal" hypothesis views it as a signal concerning the characteristics of the agent or of the task. The incomplete contract view appears to offer the best overall explanation for our results. We also find that high-powered monetary incentives do not "crowd out" intrinsic motivation, but may elicit "too much" effort when intrinsic motivation is very high.

Innovation, Spillovers and Venture Capital Contracts

Innovative start-ups and venture capitalists are highly clustered: Silicon Valley is probably the best-known example. Clusters differ in the contracts they use, and in how they perform. I explore the link between spillovers, contractual design and performance. I find that more "incomplete" contracts, with fewer contingencies linking entrepreneurs’ rewards to performance benchmarks, become optimal when positive spillovers are large. The contracts enable the innovative entrepreneur and his investor to extract some of the surplus they generate through positive spillovers for new entrants. This provides a new rationale for contractual incompleteness, and may help to explain observed contractual practice in Silicon Valley

Contractual Execution, Strategic Incompleteness and Venture Capital

Contractual execution generates hard information, available to the contracting parties, even when contracts are secretly executed. Building on this simple observation, the paper shows that incomplete contracts can be preferred to complete contracts. This is because (i) execution of incomplete contracts reveals less information to outside parties, giving rise to strategic gains; (ii) secretly executed complete contracts could not do better, given the possible strategic uses of the hard information generated by execution of the contract. The key effects at work are explored in the case of financial contracts for innovative start-up companies, providing a rationale for the observed differences in the extent to which venture capital contracts include a variety of contingencies, and for how this varies across industries and geographically