This dissertation focuses on understanding and modeling how contracts function in practice. The existing principal-agent literature usually involves two players: a principal (investors) provides capital to an agent (managers or entrepreneurs) on a project subject to asymmetric information. However, many real financing arrangements between firms and investors are intermediated by another agent - a bank, a venture capitalist, or a fund family, etc. In these three-tier settings, there are two contracts to deal with two conflicts of interest - a framework that simply hasn't been studied thoroughly in the principal-agent literature.
The first chapter is co-authored with my Ph.D. advisors Prof. Andrea M. Buffa and Prof. Lucy White. In this chapter, we consider a general economic setting in which a principal has all the bargaining power, and she has to hire two agents exerting complementary efforts on her project. The principal chooses from two contracting schemes - direct contracting and delegated contracting - whether to contract directly with both agents or instead to contract with one agent alone and delegate this agent to contract with the other agent. We find that delegated contracting can be optimal when contracts are private. With direct contracting, each agent fears that the principal will opportunistically reduce the other agents' bonus, muting incentives to exert effort. With delegated contracting, one agent observes the contract of the agent he hires, alleviating effort concerns, but allowing rent extraction. In delegating, the principal trades off the losses of control and rent extraction by the hiring agent against the gains from improved observability and effort. We find that it is optimal for the principal to delegate when the hiring agent is sufficiently skilled or the effort complementarity is sufficiently strong.
The second chapter considers an entrepreneurial finance setting in which an entrepreneur needs two things - expert advice and capital - in addition to her own idea and effort. The entrepreneur has all the bargaining power, and she chooses to finance her project from two sources: angels and venture capitalists. Venture capitalists are different from angels in two aspects. First, angels are individuals investing their own capital, while venture capitalists are intermediaries investing on behalf of limited partners (LPs). Second, venture capitalists provide expert advice while angels don't. With angel financing, the entrepreneur obtains expert advice from a consultant who is independent of the angels. With venture capital financing, the entrepreneur obtains expert advice bundled together with capital from a venture capitalist only. I show that when contracts are private, raising capital directly from angels is more expensive because the entrepreneur has the incentive to cut down on expert advice to save money. Angels optimally set a higher cost of capital to be compensated for the lack of verifiability. On the other hand, LPs are able to infer the amount of expert advice through the venture capitalist's shares in the venture. I show that venture capital financing is optimal for the entrepreneur in competitive labor and capital markets. Moreover, convertibles arise endogenously as the optimal security held by the venture capitalist. Convertible securities have features of both debt and equity, allowing the entrepreneur to provide enough incentives to the venture capitalist while minimizing the cost of capital from the LPs.
The third chapter further analyzes the entrepreneur's optimal financing problem in which venture capital is scarce relative to angel capital. Compared with competitive venture capital, the venture capitalist's compensation stays the same while the LPs demand a higher return. The entrepreneur and the venture capitalist share the extra cost of financing, and their expected payoffs and the project's profitability decrease in the scarcity level of venture capital. With venture capital financing, the entrepreneur trades off the loss due to the scarcity of venture capital against the gains from the improved transparency in contracting. I find that angel financing is optimal when venture capital is sufficiently scarce. Compared with angel financing, the investors as LPs demand a higher return than angels only when venture capital is scarcer than what it makes angel financing optimal.
| Identifer | oai:union.ndltd.org:bu.edu/oai:open.bu.edu:2144/41267 |
| Date | 07 July 2020 |
| Creators | Liu, Qing |
| Contributors | White, Lucy, Buffa, Andrea M. |
| Source Sets | Boston University |
| Language | en_US |
| Detected Language | English |
| Type | Thesis/Dissertation |
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