Multistage Financing: Milestone Bonuses or Deferred Compensation

58 Pages Posted: 2 Jun 2022 Last revised: 13 Oct 2022

See all articles by Kerry Back

Kerry Back

Rice University - Jesse H. Jones Graduate School of Business

Ali Kakhbod

University of California, Berkeley

Hao Xing

Boston University - Questrom School of Business

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

Suggested Citation

Back, Kerry and Kakhbod, Ali and Xing, Hao, Multistage Financing: Milestone Bonuses or Deferred Compensation (May 1, 2022). Available at SSRN: https://ssrn.com/abstract=4117826 or http://dx.doi.org/10.2139/ssrn.4117826

Kerry Back

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States

Ali Kakhbod (Contact Author)

University of California, Berkeley ( email )

Haas School of Business
2220 Piedmont Ave
Berkeley, CA 94720
United States

Hao Xing

Boston University - Questrom School of Business ( email )

595 Commonwealth Avenue
Boston, MA MA 02215
United States

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