Replacing Management or Not: Contract Renegotiation to Prevent Double Moral Hazards of Venture Capital Investments

Abstract

During the venture capital development, replacing the management work team or keeping up the status quo is a key strategy choice for venture capitalist and venture entrepreneur about the long-term development of enterprise and the control right transferring. In fact, the contract designing focuses on the distribution of cash flow to encourage both efforts in order to avoid double moral hazard, and the strategy behavior has similar effects according to the developing condition of venture enterprise. In this paper, we consider both contract design and strategic behavior, regarding this strategic behavior choice as a motivator and combining strategic behavior with financial instrument options. The main innovation is to redesign and optimize the contract based on dynamic perspective, which will analyze initial contract designed to motivate both sides’ effort if a venture enterprise is in good state, and then renegotiate whether to replace the management work team or keep up the status quo according to the venture enterprise’s development state in the process of venture investment cooperation. The paper also puts forward some conclusions: joint effort of both sides can be motivated through strategic behavior choice and then lead to increasing the overall value of the venture enterprise; after the venture enterprise has gained private benefits in the early stage, the venture capitalist needs to make appropriate assignments and demisability in benefits to remotivate the venture enterprise’s efforts, aiming to further balance venture enterprise’s private benefits and the earnings redistributed by venture capitalist.