A Two-Sided Matching Model of Monitored Finance

Abstract

We analyse a model of two-sided matching and incentive contracts where expert investors (venture capitalists) with different monitoring capacities are matched with firms with different levels of initial wealth. Firms do not have sufficient start-up capital to cover their project costs and hence, seek external financing. In equilibrium, the matching and the payoffs of the venture capitalists and the firms are determined simultaneously. More effective VCs and higher-wealth firms consume higher payoffs. We also show that, in equilibrium VCs with higher monitoring ability invest in firms with lower initial wealth following a negatively assortative matching pattern.

Keywords: Venture capital, Assortative matching, Incentive contracts

JEL Classification: C78, D82, E44, G24