Venture Capital Finance-Eliminating Double Sided Moral Hazards through Trade-off between Economic and Behavioural Economic Aspects-A Case Analysis

Dhanesh Kumar Khatri (Institute of Management Studies, Bikaner, 334001, State, Rajasthan, Country, India)


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.


Asymmetric information; Behavioural economic aspect; Moral hazards

Full Text:



[1]Shane, S., Venkataraman, S. Entrepreneurship as a field of research: The promise of entrepreneurship as a field of research.’ Academy of management review, 2000, 26 (1):13-17.

[2]Fenn GW, Liang N, Prowse S. The Economics of the Private Equity Market. Washington, DC: Board of Governors of the Federal Reserve System, 1995.

[3]Branscomb Lewis M, Auerswald Philip E. Taking Technical Risks: How Innovators, Managers, and Investors Manage Risk in High-Tech Innovations. Cambridge, MA: MIT Press, 2001.

[4]Baker, Malcolm P., Gompers, Paul A. Executive Ownership and Control in Newly Public Firms: The Role of Venture Capitalists, 1999. Available at SSRN: https:// or ssrn.165173.

[5]Smith, D.G. Venture capital contracting in the information age. Journal of Small and Emerging Business Law 2, 1998, 133-174.

[6]Richard Fairchild. An entrepreneur’s choice of venture capitalist or angel financing A behavioral game-theoretic approach, Journal of Business Venturing, 2011, 26, 359-374.

[7]Mehta, Vijay. Principal-Agent Issues in Private Equity and Venture Capital, Wharton Research Scholars, 2004.

[8]Cable, D.M., Shane, S. A prisoner’s dilemma approach to entrepreneur-venture capitalist relationships. Academy of Management Review 1997, 22(1):142-176.

[9]Klausner, Michael D., Litvak, Kate. What Economists Have Taught Us About Venture Capital Contracting? Bridging The Entrepreneurial Financing Gap: Linking Governance with Regulatory Policy, Michael Whincop, ed., Ashgate, 2001. Available at SSRN: https://ssrn. com/abstract=280024 or ssrn.280024

[10]De Bettignies and Brander. Financing entrepreneurship: Bank finance versus venture capital, Journal of Business Venturing, 2007, 22(6):808-832.

[11]Smith, D.G. Venture capital contracting in the information age. Journal of Small and Emerging Business Law 2, 1998, 133-174.

[12]Landier, A. Start-up financing: banks versus venture capital. MIT. Working paper. Dean A. Shepherd, Andrew Zacharakis. The venture capitalist-entrepreneur relationship: Control, trust and confidence in co-operative behavior , Venture Capital, Taylor & Francis Journals, 2001, 3(2):129-149.

[13]Jiajia Chang, Zhijun Hu. Venture Capital Contracting with Double-Sided Moral Hazard and Fairness Concerns, Mathematical Problems in Engineering Volume 2018, Article ID 5296350, 13 pages, 2018.

[14]Aghion, Phillippe, Patrick Bolton. An incomplete contracts approach to financial contracting, Review of Economic Studies, 1992, 77: 338-401.

[15]Berg, J., Dickhaut, J., McCabe, K. Trust, reciprocity and social history, Games and Economic Behavior, American Economic Review, 1995, 10:122-142.

[16]Bolton, G., Ockenfels, A. ERC-a theory of equity, reciprocity, and competition’, American Economic Review, 2000, 90:166-193.

[17]Sally, D. On sympathy and games, Journal of Economic Behavior and Organization, 2001, 44:1-30.

[18]Kim, W.C., Mauborgne, R.A. Implementing global strategies: the role of procedural justice, Strategic Management Journal, 1991, 12:125-143.

[19]Kim, W.C., Mauborgne, R.A. Procedural justice, attitudes, and subsidiary top management compliance with multinationals’ strategic decisions, Academy of Management Journal, 1993, 36(3):502-526.

[20]De Clercq, D., Sapienza, H. The creation of relational rents in venture capitalist-entrepreneur dyads. Venture Capital 2001, 107-127.

[21]Shepherd, D., Zacharakis, A. The venture capitalist– entrepreneur relationship: control, trust and confidence in co-operative behaviour. Venture Capital, 2001: 129-149.

[22]Fairchild, R., Mai, Y. The effect of the legal system and empathy in venture capital contracting: theory and evidence, International Journal of Behavioural Accounting and Finance, 2013, 4(1):32-53.

[23]Breugst, N., et al. How should we divide the pie? Equity distribution and its impact on entrepreneurial teams, Journal of Business Venturing, 2014.

[24]Anthony C. Klotz, Keith M. Hmieleski, Bret H. Bradley: New Venture Teams: A Review of the Literature and Roadmap for Future Research. Journal of Management, 2014, 40(1):226-255 . DOI: 10.1177/0149206313493325.

[25]Shepherd, D., Zacharakis, A. The venture capitalist–entrepreneur relationship: control, trust and confidence in co-operative behavior. Venture Capital, 2001, 129-149.

[26]Sapienza, H., Korsgaard, M. Procedural justice in entrepreneur–investor relations. The Academy of Management Journal, 1996, 39:544-574.

[27]Sahlman, W. The structure and governance of venture capital organizations, Journal of Financial Economics, 1990, 27:473-524.

[28]Utset, M. Reciprocal fairness, strategic behaviour and venture survival: a theory of venture capital-financed firms. Wisconsin Law Review, 2002(1):48-166.

[29]Bruton, G.D., Ahlstrom, D, Singh, K. The impact of the institutional environment on the venture capital industry in Singapore, Venture Capital, 2002, 4:197-218.

[30]Allen, F., Song, W. Venture capital and corporate governance. Wharton Financial Institutions Center. Working paper, 2002.

[31]Smith, D.G. Venture capital contracting in the information age. Journal of Small and Emerging Business Law 2, 1998, 133-174.

[32]Hui Fu, Jun Yang, Yunbi An. Contracts for venture capital financing with double-sided moral hazard, Small Business Economics, Springer, 2019, 53(1):129-144.

[33]Steven N. Kaplan, Per Stromberg. Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts NBER Working Paper No. 7660 April, 2000.

[34]Hellman, Thomas. The allocation of control rights in venture capital contracts, Rand Journal of Economics, 1998, 29(1):57-76.

[35]Steven N. Kaplan, Per Stromber. Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts NBER Working Paper No. 7660, 2000.

[36]Michael Klausner, Kate Litvak. What Economists Have Taught Us About Venture Capital Contracting, Stanford Law School Working Paper, 2001.



  • There are currently no refbacks.
Copyright © 2021 Dhanesh Kumar Khatri Creative Commons License
This work is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.