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Underdiversification in Private Companies: Required Returns and Incentive Effects

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  • Müller, Elisabeth

Abstract

Owners of private companies are often highly underdiversified which exposes them to idiosyncratic risk. We investigate the consequences of underdiversification at the company level. Information on US companies and their owners is obtained from the Survey of Consumer Finances and the Survey of Small Business Finances. Underdiversification, measured as the share of the owner's net worth invested in the company, has a significant positive relationship with profitability, measured as the return on equity. We identify two causes for this underdiversification effect: higher required returns and higher effort. The results have important consequences for investment decisions at private companies. --

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Paper provided by ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research in its series ZEW Discussion Papers with number 04-29.

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Date of creation: 2004
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Handle: RePEc:zbw:zewdip:2183

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Keywords: underdiversification; required returns; incentives; private companies; wealth; entrepreneurship;

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Cited by:
  1. Müller, Elisabeth, 2007. "How does owners' exposure to idiosyncratic risk influence the capital structure of private companies?," ZEW Discussion Papers 05-14 [rev.2], ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.

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