Contracting Among Founders
54 Pages Posted: 7 Dec 2011 Last revised: 10 Oct 2013
Date Written: October 9, 2013
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 paper derives 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. Delayed contracting becomes more attractive when there are significant doubts about the skills of founders. Contingent contracts with vesting of shares may be used to mitigate inefficiencies in the team formation process. Interestingly we show that outside investors cannot easily undo ex-post inefficient founder agreements. We also show that laws that provide protection to implied partnerships may have the unintended effect of encouraging more formal contracting.
Keywords: Entrepreneurship, partnership, founders, contracting, vesting, skill uncertainty, contract law
JEL Classification: D82, D86, K12, L26
Suggested Citation: Suggested Citation