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Entrepreneurs, legal institutions and firm dynamics

Author

Listed:
  • Neus Herranz

    (University of Illinois)

  • Stefan Krasa

    () (University of Illinois)

  • Anne P. Villamil

    () (University of Iowa)

Abstract

This paper assesses the impact of legal institutions on firm dynamics in a model where entrepreneurs have heterogeneous risk aversion, credit constraints and may default. Entrepreneurs choose firm size, capital structure, consumption, default and whether to incorporate. We find that less risk-averse entrepreneurs tend to incorporate while more risk-averse entrepreneurs do not; this occurs because leaving some personal assets exposed by not incorporating allows more risk-averse borrowers to credibly commit to lower default rates. We show that incorporation is determined by two effects: the standard effect that bankruptcy insures low firm returns and a new “scale effect”—more risk-averse entrepreneurs run smaller firms and default more often. The more risk-averse choose to leave some personal assets unshielded in bankruptcy due to a commitment problem that dominates the value of insurance. The less risk-averse run larger firms, default less and incorporate.

Suggested Citation

  • Neus Herranz & Stefan Krasa & Anne P. Villamil, 2017. "Entrepreneurs, legal institutions and firm dynamics," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 63(1), pages 263-285, January.
  • Handle: RePEc:spr:joecth:v:63:y:2017:i:1:d:10.1007_s00199-016-1026-8
    DOI: 10.1007/s00199-016-1026-8
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Fossen, Frank M., 2019. "Entrepreneurship over the Business Cycle in the United States: A Decomposition," IZA Discussion Papers 12499, Institute of Labor Economics (IZA).

    More about this item

    Keywords

    Entrepreneur; Legal environment; Incorporated; Unincorporated; Endogenous default; Bankruptcy; Commitment; Insurance; Firm size; Risk aversion; Heterogeneity; Credit constraints; Capital structure; Debt;

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • E01 - Macroeconomics and Monetary Economics - - General - - - Measurement and Data on National Income and Product Accounts and Wealth; Environmental Accounts
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance
    • L26 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Entrepreneurship

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