Working Paper: CEPR ID: DP18227
Authors: Shiqi Chen; Bart Lambrecht
Abstract: Legal scholars highlight the tensions that exist between different classes of shareholders in startups. We model a startup owned by undiversified investors with heterogeneous capital contributions and risk preferences. A social planner runs the firm on behalf of all investors. We compare investors' expected utility with a hypothetical first-best decentralized benchmark. The startup's optimal investment policy is pro-cyclical and a time-varying weighted average of shareholders' optimal investment policies. The optimal contracts issued to investors are tailor-made, interdependent, and include equity claims resembling preferred stock with heterogeneous payout caps, leading to a complex capitalization table as more investors join the startup.
Keywords: Investment; Payout; Startup; Risk Preferences; Group Policy
JEL Codes: G32; G34; G35
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| social planner's policies (P21) | shareholders' first-best expected lifetime utility (D15) |
| startup's growth (M13) | optimal investment policy is procyclical (G11) |
| equity shares of investors (G12) | time-varying weighted average of individual shareholders' optimal investment policies (G11) |
| contract design (K12) | investor behavior (G41) |
| risk preferences of investors (G11) | payout structures (G35) |
| diversity in equity contracts (J41) | time-varying equity shares (G12) |
| time-varying equity shares (G12) | complicated governance structure (L22) |
| complicated governance structure (L22) | startup's investment and payout decisions (D25) |