Three Tiers and Thresholds: Incentives in Private Market Investing
Fuente:
arXiv
Saved in:
| Main Authors: | , |
|---|---|
| Format: | Preprint |
| Published: |
2025
|
| Subjects: | |
| Online Access: | |
| Tags: |
Add Tag
No Tags, Be the first to tag this record!
|
| _version_ | 1866915690871521280 |
|---|---|
| author | Keppo, Jussi Li, Yingkai |
| author_facet | Keppo, Jussi Li, Yingkai |
| contents | This paper studies optimal contract design in private market investing, focusing on internal decision making in venture capital and private equity firms. A principal relies on an agent who privately exerts costly due diligence effort and then recommends whether to invest. Outcomes are observable ex post even when an opportunity is declined, allowing compensation to reward both successful investments and prudent decisions to pass. We characterize profit maximizing contracts that induce information acquisition and truthful reporting. We show that three tier contracts are sufficient, with payments contingent on the agent's recommendation and the realized return. In symmetric environments satisfying the monotone likelihood ratio property, the optimal contract further simplifies to a threshold contract that pays only when the recommendation is aligned with an extreme realized return. These results provide guidance for performance based compensation that promotes diligent screening while limiting excessive risk taking. |
| format | Preprint |
| id |
arxiv_https___arxiv_org_abs_2512_19405 |
| institution | arXiv |
| publishDate | 2025 |
| record_format | arxiv |
| spellingShingle | Three Tiers and Thresholds: Incentives in Private Market Investing Keppo, Jussi Li, Yingkai Computer Science and Game Theory Theoretical Economics This paper studies optimal contract design in private market investing, focusing on internal decision making in venture capital and private equity firms. A principal relies on an agent who privately exerts costly due diligence effort and then recommends whether to invest. Outcomes are observable ex post even when an opportunity is declined, allowing compensation to reward both successful investments and prudent decisions to pass. We characterize profit maximizing contracts that induce information acquisition and truthful reporting. We show that three tier contracts are sufficient, with payments contingent on the agent's recommendation and the realized return. In symmetric environments satisfying the monotone likelihood ratio property, the optimal contract further simplifies to a threshold contract that pays only when the recommendation is aligned with an extreme realized return. These results provide guidance for performance based compensation that promotes diligent screening while limiting excessive risk taking. |
| title | Three Tiers and Thresholds: Incentives in Private Market Investing |
| topic | Computer Science and Game Theory Theoretical Economics |
| url | https://arxiv.org/abs/2512.19405 |