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How Does Owners' Exposure to Idiosyncratic Risk Influence the Capital Structure of Private Companies?

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  • Müller, Elisabeth

Abstract

This paper identifies the entrepreneur's exposure to idiosyncratic risk as an important determinant of the capital structure of private companies. The exposure to idiosyncratic risk is approximated by the share of personal net worth invested in one company (SNWI). Exposure to idiosyncratic risk increases cost of equity capital since higher equity returns are required as compensation. This makes bank financing more attractive. We find that SNWI increases the demand for new bank loans whereas we cannot identify an effect on the supply. Equilibrium values of leverage increase significantly in SNWI but there is no effect on the equilibrium interest rate. --

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Bibliographic Info

Paper provided by ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research in its series ZEW Discussion Papers with number 05-14.

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Date of creation: 2005
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Handle: RePEc:zbw:zewdip:2904

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Keywords: entrepreneurial investment; capital structure; underdiversification; private companies;

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References

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  1. Ken Cavalluzzo & Linda Cavalluzzo & John Wolken, 1999. "Competition, small business financing, and discrimination: evidence from a new survey," Proceedings, Federal Reserve Bank of Chicago, issue Mar, pages 180-266.
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Cited by:
  1. Elston Julie Ann & Rondi Laura, 2006. "Shareholder Protection and the Cost of Capital Empirical Evidence from German and Italian Firms," CERIS Working Paper 200608, Institute for Economic Research on Firms and Growth - Moncalieri (TO).

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