Designing Incentives in Startup Teams: Form and Timing of Equity Contracting

35 Pages Posted: 18 Sep 2017

See all articles by Evgeny Kagan

Evgeny Kagan

Johns Hopkins University - Carey Business School

William S. Lovejoy

University of Michigan, Stephen M. Ross School of Business

Stephen Leider

University of Michigan, Stephen M. Ross School of Business

Date Written: June 1, 2017

Abstract

Entrepreneurial teams assign equity positions in their startups using a term sheet that details equity splits and conditions for being granted those splits. It is conventional wisdom in the entrepreneurial press that equal splits are poor choices. The conventional logic is that by not connecting rewards to contribution level equal split contracts can encourage free-riding behaviors. We experimentally test this conventional wisdom, among other entrepreneurial contracting hypotheses. Our results confirm the relationship between equal splits and depressed effort and contribution, but suggest a different causal sequence relative to conventional wisdom. Rather than the contract form being the primitive and the behavior the derived consequence, our results suggest the reverse. The differences in contract performance are driven primarily by the sorting of high contributors into non-equal contracts and of low contributors into equal contracts. However, delaying the contracting mitigates these sorting effects, reducing the effort gap between contracts. Taken together, our results suggest that both investors and founders should pay as much (or more) attention to personality type as they do to contract form, but if one is stuck with a given set of personalities delayed contracting (more so than contract form) can improve performance.

Keywords: Entrepreneurial operations, Startups, Contracting, Behavioral operations, Innovation

JEL Classification: C90, L26

Suggested Citation

Kagan, Evgeny and Lovejoy, William S. and Leider, Stephen, Designing Incentives in Startup Teams: Form and Timing of Equity Contracting (June 1, 2017). Ross School of Business Paper No. 1372. Available at SSRN: https://ssrn.com/abstract=3037444 or http://dx.doi.org/10.2139/ssrn.3037444

Evgeny Kagan (Contact Author)

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

William S. Lovejoy

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Stephen Leider

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

HOME PAGE: http://www-personal.umich.edu/~leider/

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