Managers, Entrepreneurs and Investors: The Consequences of Corporate Cheating for Firm Structure Under Different Wealth Distributions

When a manager, an entrepreneur and outside investors interact under asymmetric information, outsiders limit their stake to eliminate insider cheating; and entrepreneurs offer managers a contractual wage sufficient to deter cheating. When capital is too expensive, this contract is infeasible, and owner-managers rule, otherwise entrepreneurialmanagerial pairs emerge. Individuals with managerial ability endogenously prefer working for entrepreneurs to establishing their own firms, and the latter to playing a non-managerial role while hiring another manager. We endogenize firm formation and structure and establish a unique equilibrium for any distribution of wealth and managerial ability. The model has many developmental applications.