A Dynamic Delegated Investment Model of SPACs

Abstract

We study SPACs in a continuous-time delegated investment model. Our model is built upon three unique features of SPACs: the sponsor and the investor are only partially aligned, a SPAC has a short time horizon, and the investor has the final control over investment approval. Due to the misalignment in incentives, the sponsor has an increasing incentive to propose unprofitable projects to the investor; in response, the investor exerts more stringent screening based on her information. Although the screening helps curb the sponsor’s moral hazard, it also dampens the disciplining effect of partial alignment in incentives. When the investor’s information is sufficiently noisy, the second effect dominates, so giving the investor the control over investment approval reduces everyone’s welfare. This adverse effect is more pronounced if entrepreneurs’ strategic choices of SPAC or the sponsor’s strategic choice of effort are considered. We find that introducing public assessment and making the investor’s control right contingent on it may benefit both parties. We also explore whether a SPAC should be allowed to continue after the current project is disapproved by the investor.

Keywords: SPAC, delegated investment, dynamic delegation, moral hazard

JEL Classification: D82, D86, G23