Multistage Financing: Milestone Bonuses or Deferred Compensation
58 Pages Posted: 2 Jun 2022 Last revised: 13 Oct 2022
Date Written: May 1, 2022
Abstract
We develop a dynamic principal-agent model for financing a multistage project. The optimal contract displays unique features: (i) principal prefers to use deferred compensation to reward intermediate stage success before using milestone bonuses, a pecking order between these two instruments; (ii) agent's equity stake in the project is positively related to performance and is also smaller in later stages than in early ones. Moreover, monitoring and reward dynamically complement each other: when negative (positive) evidence about the agent's effort accumulates, monitoring is more intense (mild) and reward declines (grows). We propose new empirical tests of our model predictions on venture capital financing.
Keywords: Multistage projects, Moral Hazard, Monitoring, Dynamic Contracts, Project Financing
JEL Classification: J41, G35, D82, L14, M55
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