The impact of trust on private equity contracts

Abstract

This paper adresses the impact of trust on private equity contracts. Trust between investor and entrepreneur is essential to help overcome control problems, especially in an environment with severe agency risks and incomplete contracts. In this study, information about the effects of trust is collected using a simulation with 144 entrepreneurs and investors. We find that trust has an impact on the desired contracts of entrepreneurs, but not on that of investors. Our findings suggest that for parties, faced with potentially large agency problems (investors), trust and control seem to play complementary roles. On the other hand, for parties faced with smaller agency problems (entrepreneurs), trust seems to be a substitute for control.