Governance of the Investor-Entrepreneur Relationship: Empirical Support of Some Outcomes and Limitations of the Economic Approach

Cooperation is a necessary condition for the success of any social relationship or collective endeavor and is recognized to be superior to non-cooperation and individual action at achieving virtually all goals in any domain. In the Investor-Entrepreneur relationship, cooperation is believed to be more important than whatever resource invested by parties in the venture, including the financial capital itself. Research and theory in venture capital contracting, however, hint at the possibility of the governance mechanisms of the Investor-Entrepreneur relationship being uncooperative in essence and leading to significant social inefficiencies. This research investigated the extent of cooperation yielded by Opportunism-oriented Mechanisms of Governance (OMEGs) and their effects on cooperation. A sequential mixed-methods research, encompassing a Randomized Block Laboratory Experiment (RBLED) followed by Conversation Analysis (CA) and Ethnographic Content Analysis (ECA) of the post-experimental enquiry, was used to assess the effectiveness of monitoring, transaction procedures, and reliance on the market for reputation in inducing cooperation, with the ultimate aim of generating an in-depth understanding of their outcomes and limitations. There was a strong support that Opportunism-oriented Mechanisms of Governance (OMEGs) are generally ineffective in yielding cooperation in the financing relationship, and that their use involves high economic and social costs, which induce significant social inefficiencies. The first-order central understanding gained from the study is that research and theory have failed to draw the crucial distinction between opportunism and opportunistic behaviors. We would not have expected OMEGs to be effective in addressing opportunism and thereby inducing cooperation, inasmuch as they were not designed for that. They were designed to control opportunistic behaviors, which unfortunately are of an unparalleled volatility and versatility, always changing and migrating from controlled to uncontrollable areas. The second-order central understanding of the study is that venture capital financing is prone to social inefficiency because it relies on non-cooperative institutions rather than on cooperative institutions, which are credited with superior cost-effectiveness. A wealth of recommendations for further research stemmed from the study. Prominently among all, a call is made for the inclusion of spirituality, the parent of all morals and all ethics, in theoretical modeling and institution design, because it emerged from the study that only spirituality-based theories can help address opportunism and build trusting societies, where cooperative mechanisms of governance would prevail and increase the social efficiency of many human activities that are impaired by lack of trust. Of almost the same prominence is the claim for the improvement of current institutional structures, in order to render them more socially efficient and thereby preserve the scarce resources of our world, by moving from contractual to relational governance or by shifting from venture capital financing to venture guardianship in entrepreneurial finance.