Entrepreneurship, Business Incubation, and External Finance: An Analysis Based on the Theory of Incomplete Contracts

Abstract

This paper offers an analysis of the arrangements through which business incubators furnish seed finance and entrepreneurial-specific assets based on the theory of incomplete contracts. Specifically, I compare bargaining games in which (i) an investor offers finance under non-verifiability, which can be put to different uses by the entrepreneur, and (ii) an incubator offers a contract bundling financial provision to entrepreneurial-specific business services. The results highlight negative financial and economic consequences of incomplete contracting for entrepreneurship and how business incubation may partially overcome moral hazard risks, fostering investment in marginal firms that would not otherwise obtain funds and reducing the rate of start-up failure.