Contractual incompleteness and the optimality of equity joint ventures

Abstract

Firms engaged in the pooling of complementary skills often choose the Equity Joint Venture (EJV) over alternative profit-sharing arrangements. This paper addresses the issue of how equity shares are different from profit shares. It is shown that, in settings of contractual incompleteness, marketable equity ownership, when compared to non-transferable profit-sharing contracts, provides better ex ante incentives to the parties involved by mitigating ex post hold-up problems. Among other things, the prevalence of the 51-49 or 50-50 EJV in which one party has 51 percent (or 50 percent) equity shares is explained.