Dynamic incentive contracts for venture capital with diversified task relationships in continuous time

Dahai LI, Huan WANG, Tao DING, Liang LIANG

Systems Engineering - Theory & Practice ›› 2025, Vol. 45 ›› Issue (5) : 1553-1571.

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Systems Engineering - Theory & Practice ›› 2025, Vol. 45 ›› Issue (5) : 1553-1571. DOI: 10.12011/SETP2023-2592

Dynamic incentive contracts for venture capital with diversified task relationships in continuous time

  • Dahai LI1, 2, 3(Email), Huan WANG4(Email), Tao DING3,5, Liang LIANG2,3,*(Email)
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Abstract

To deal with the complex and ever-changing business environment, startups employ diversification techniques. As a result of these diversification techniques, entrepreneurs must put effort over many tracks. Diversification creates new tasks for corporate development, and these duties may be cooperative or competitive in nature. The impact of inter-task linkages on dynamic contract design and investor expected returns is investigated in this study. Furthermore, due to the disparities in agency structures amongst organizations, this study is separated into two cases: Multi-agent and single-agent. This study gives optimal dynamic contracts and investor expected profit equations under both agency structures using the martingale approach of continuous-time principal-agent theory, and explores the impact of varied task relationships on them. Under the multi-agent model, the entrepreneur's response function to incentives is independent of task relationships, whereas task relationships only affect the entrepreneur's response function under the single-agent model. There is a fixed ratio between the entrepreneur's multiple efforts in the single-agent model, and the ratio is governed by task linkages and cost considerations. Using the background of venture capital, this study builds a particular example of entrepreneurs who consistently exert utmost effort and discovers that conflict connections diminish expected returns while collaborative partnerships increase expected returns. When there is poor task collaboration or disagreement, investors prefer the multi-agent model. But as task collaboration improves, the single-agent approach is preferable.

Key words

diversified strategy / dynamic contract / principal-agent theory / venture capital

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Dahai LI, Huan WANG, Tao DING, Liang LIANG. Dynamic incentive contracts for venture capital with diversified task relationships in continuous time. Systems Engineering - Theory & Practice, 2025, 45(5): 1553-1571 https://doi.org/10.12011/SETP2023-2592

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Funding

National Natural Science Foundation of China (72401001, 72188101, 72271080); Anhui Provincial Scientific Research Planning Project (2022AH050104, 2022AH050035); Fundamental Research Funds for the Central Universities of China (PA2024GDSK0110); Double First-class Discipline Construction Project (PA2024GDGP0032)

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