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Entrepreneurs, Risk Aversion, and Dynamic Firms

Author

Listed:
  • Neus Herranz
  • Stefan Krasa
  • Anne P. Villamil

Abstract

How do entrepreneurs vary firm size, capital structure, and default to manage risk? We show that more risk-averse entrepreneurs run smaller, more highly leveraged firms and default less, because running a smaller firm with higher debt reduces personal funds at risk in the firm. Optimal default depends on ex ante debt, consumption forgone from firm liquidation, and owner capacity to inject funds. We show that entrepreneurs sacrifice current consumption in the hope of future success that never materializes for the bottom 25 percent, but entrepreneurship is a path toward great wealth and high consumption for the top quartile.

Suggested Citation

  • Neus Herranz & Stefan Krasa & Anne P. Villamil, 2015. "Entrepreneurs, Risk Aversion, and Dynamic Firms," Journal of Political Economy, University of Chicago Press, vol. 123(5), pages 1133-1176.
    • Handle: RePEc:ucp:jpolec:doi:10.1086/682678
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    References listed on IDEAS

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    1. Anna L. Paulson & Robert M. Townsend & Alexander Karaivanov, 2006. "Distinguishing Limited Liability from Moral Hazard in a Model of Entrepreneurship," Journal of Political Economy, University of Chicago Press, vol. 114(1), pages 100-144, February.
    2. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
    3. Andrew Glover, 2010. "Bankruptcy, Incorporation, and the Nature of Entrepreneurial Risk," 2010 Meeting Papers 1010, Society for Economic Dynamics.
    4. Florin Bidian & Camelia Bejan, 2015. "Martingale properties of self-enforcing debt," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 60(1), pages 35-57, September.
    5. Stefan Krasa & Tridib Sharma & Anne Villamil, 2008. "Bankruptcy and firm finance," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 36(2), pages 239-266, August.
    6. Galina Vereshchagina & Hugo A. Hopenhayn, 2009. "Risk Taking by Entrepreneurs," American Economic Review, American Economic Association, vol. 99(5), pages 1808-1830, December.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Duncan, Alfred & Nolan, Charles, 2014. "Disputes, Debt and Equity," SIRE Discussion Papers 2015-29, Scottish Institute for Research in Economics (SIRE).
    2. Gaillard, Alexandre & Kankanamge, Sumudu, 2018. "Entrepreneurship, Labor Market Mobility and the Role of Entrepreneurial Insurance," TSE Working Papers 18-929, Toulouse School of Economics (TSE).
    3. repec:gam:jijfss:v:6:y:2018:i:3:p:71-:d:162242 is not listed on IDEAS
    4. repec:eee:deveco:v:133:y:2018:i:c:p:162-186 is not listed on IDEAS
    5. Federico Esposito, 2016. "Risk Diversification and International Trade," 2016 Meeting Papers 302, Society for Economic Dynamics.
    6. repec:eee:touman:v:56:y:2016:i:c:p:191-204 is not listed on IDEAS
    7. repec:eee:jeborg:v:143:y:2017:i:c:p:116-132 is not listed on IDEAS
    8. repec:red:issued:16-340 is not listed on IDEAS
    9. Mariacristina De Nardi & Giulio Fella, 2017. "Saving and Wealth Inequality," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 26, pages 280-300, October.
    10. repec:kap:annfin:v:13:y:2017:i:2:d:10.1007_s10436-017-0293-0 is not listed on IDEAS
    11. repec:spr:grdene:v:27:y:2018:i:3:d:10.1007_s10726-018-9563-0 is not listed on IDEAS
    12. Carrillo, Paul & Emran, M. Shahe, 2018. "Loss Aversion, Transaction Costs, or Audit Trigger? Learning about Corporate Tax Compliance from a Policy Experiment with Withholding Regime," MPRA Paper 87445, University Library of Munich, Germany.
    13. Chivers, David, 2017. "Success, survive or escape? Aspirations and poverty traps," Journal of Economic Behavior & Organization, Elsevier, vol. 143(C), pages 116-132.
    14. 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.
    15. Joel M. Vanden, 2016. "Optimal capital structures for private firms," Annals of Finance, Springer, vol. 12(2), pages 245-273, May.
    16. David Chivers & Zhigang Feng & Anne Villamil, 2017. "Employment-based Health Insurance and Misallocation: Implications for the Macroeconomy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 23, pages 125-149, January.
    17. Jim Y. Jin & Shinji Kobayashi, 2016. "Impact of risk aversion and countervailing tax in oligopoly," Annals of Finance, Springer, vol. 12(3), pages 393-408, December.

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