Original Paper

Experimental Economics

, Volume 17, Issue 4, pp 586-614

Incentive effects of funding contracts: an experiment

  • J. Philipp ReißAffiliated withInstitute of Economics (ECON), Karlsruhe Institute of Technology (KIT) Email author 
  • , Irenaeus WolffAffiliated withTWI/University of Konstanz

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Abstract

We examine the incentive effects of funding contracts on entrepreneurial effort and on allocative efficiency. We experiment with funding contracts that differ in the structure of investor repayment and, thus, in their incentives for the provision of entrepreneurial effort. Theoretically the replacement of a standard debt contract by a repayment-equivalent non-monotonic contract reduces effort distortions and increases efficiency. Likewise, distortions can be mitigated by replacing outside equity by a repayment-equivalent standard-debt contract. We test both hypotheses in the laboratory. Our results reveal that the incentive effects of funding contracts must be experienced before they are reflected in observed behavior. With sufficient experience, observed behavior is either consistent with or close to theoretical predictions and supports both hypotheses. If we allow for entrepreneur-sided manipulations of project outcomes, we find that non-monotonic contracts lose much of their appeal.

Keywords

Hidden information Funding contracts Incentives Experiment Standard debt contract Non-monotonic contract State manipulation

JEL Classification

C91 D82 G21