Contract Design for Start-Ups, Business Incubators, and Venture Capitalists: The Effect of Overconfidence

Abstract

New ventures need a lot of start-up capital in the initial stage, but it is extremely hard to get financing due to a lack of sufficient and performance records. Business incubator, as an open innovation platform specializing in cultivating potential start-ups, can serve as an intermediary to help nascent firms access to venture capitalists. This article builds a moral hazard model for start-up, business incubator, and venture capitalist, setting the timeline and impact factors of the cooperative process. Through the model calculation and numerical simulation, the relationship between the overconfidence of the start-up and the tripartite cooperation is explored, and the reward and punishment system is added to optimize the model. This article illustrates that the increase of start-up's overconfidence within a certain range is conducive to lower the threshold of financing for start-ups, improve its own optimal effort level, and is closely related to the equity allocated by the three parties. A reward and punishment mechanism is proposed and has a positive effect in motivating the start-ups, while the regulation can be relaxed for overconfident start-ups.