Contracting Among Founders

Abstract:     
This paper develops a theory of contracting among founders of a new firm. It asks at what stage founders agree to commit to each other, how they structure optimal founder contracts, and how this affects team formation, ownership, incentives, and performance. The most important insights are that (i) there is a trade-off between upfront contracting, which can result in teams with ineffective founders, versus delayed contracting, which can enable some founders to appropriate ideas and start their own firms; (ii) greater uncertainty about founder skills makes delayed contracting more attractive; and (iii), contingent contracts with vesting of shares may be used to mitigate inefficiencies in the team formation process. We also show that laws that provide protection to implied partnerships may have the unintended effect of encouraging more formal contracting.

Number of Pages in PDF File: 45

Keywords: Entrepreneurship, partnership, founders, contracting, vesting, skill uncertainty, contract law

JEL Classification: D82, D86, K12, L26

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