The Entrepreneur's Reward for Self‐policing

The collaboration among people is often subject to shirking; the net gain from the collaboration depends on the contract governing it. I argue that the entrepreneur assumes the role of the residual claimant because his actions are more costly to monitor than those of the factors with which he collaborates. By offering fixed pay contracts to others and himself becoming residual claimant, the entrepreneur curtails his incentive to gain at the expense of his partners, and the net gain from the collaboration is then maximized. Costly monitoring applies to both labor and capital, and thus the entrepreneur may supply both labor services and capital. The entrepreneur's capital serves to guarantee the pay of the other factors.