Career Concerns and Pay-for-Performance Contracts

The current paper studies a multiple agent setting with career concerns and pay for performance contracts. In the two-period model, an Investor finances and offers a share of the profits to the Venture Capitalist. The Venture Capitalist, who faces career concerns, decides on the risk type of the project and the contract he will offer to the Entrepreneur. The Entrepreneur decides the level of effort he will exert. Although the risk type of the project and the outcome are observable, the ability of the Venture Capitalist is unknown to all the agents. The exerted effort and the quality of the project are also not observable. The main finding is that Venture Capitalists will choose high risk projects when these allow them to send a signal regarding their ability even if it is a non optimal strategy. The optimal/equilibrium contracts are characterized and it is shown that the Venture Capitalist acts according to advancing his career prospects and signaling his ability. The conditions under which each strategy is optimal are depicted