Moral Hazard Reduction in Entrepreneurial Financing An application to Profit and Loss Sharing Contracts

In profit and loss sharing contracts, profits are shared according to a specific ratio while losses are shared according to each partner contribution ration in the project’s capital. We aim to reduce entrepreneurial effort shirking in a profit and loss sharing contract involving a VC and an entrepreneur. We use a game theoretic approach and try to find the profit-sharing ratio that would reduce the moral hazard risk of effort shirking. The game theoretic approach allows for the development of a profit-sharing ratio span of negotiation that fulfil both the incentive and participative constraints of the PLS participant