DP7413 Contractual Execution, Strategic Incompleteness and Venture Capital

Author(s): Roberta Dessí
Publication Date: August 2009
Keyword(s): competition, contingencies, execution, hard evidence, incomplete contracts, venture capital
JEL(s): D82, D86, G24, L22
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=7413

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.