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Incentive Effects of Funding Contracts: An Experiment

  • J. Philipp Reiß

    ()

    (Department of Economics, University of Maastricht, The Netherlands)

  • Irenaeus Wolff

    ()

    (Thurgau Institute of Economics at the University of Konstanz, Department of Economics, Germany)

We examine the incentive effects of funding contracts on entrepreneurial effort decisions and allocative efficiency. We experiment with funding contracts that differ in the structure of investor repayment and, therefore, in the incentives for entrepreneurial effort provision. Theoretically the replacement of a standard debt contract by a repayment-equivalent non-monotonic contract reduces effort distortions and increases efficiency. Likewise the replacement of outside equity by a repayment-equivalent standard-debt contract mitigates distortions. We test both hypotheses in the laboratory. Our results reveal that the incentive effects of funding contracts need to be experienced before they reflect in observed behavior. With sufficient experience observed behavior is consistent with the theoretical predictions and supports both hypotheses. If we allow for entrepreneur-sided manipulations of the project outcome we find that non-monotonic contracts lose its appeal.

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Paper provided by Department of Economics, University of Konstanz in its series Working Paper Series of the Department of Economics, University of Konstanz with number 2012-26.

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Length: 41 pages
Date of creation: 30 Sep 2012
Date of revision:
Handle: RePEc:knz:dpteco:1226
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