Financial Contracting with Optimistic Entrepreneurs: Theory and Evidence
This Paper looks at the effects of entrepreneurial optimism on financial contracting and corporate performance. Optimism may increase effort, but is bad for adaptation decisions as the entrepreneur underweights negative information. The first-best contract with an optimist uses contingencies to ‘bridge the gap in beliefs’. When only debt contracts are possible, we show that insurance motives lead realists to prefer long-term debt, whereas short-term debt is the optimal contract for optimists. With short-term debt, the investor: (1) gets cash-flow claims on states that the optimistic entrepreneur finds relatively unlikely, and the entrepreneur gets as much as possible from the states that they ‘dream to be true’; (2) gets control in states where the optimistic entrepreneur would behave inefficiently, which decreases the ex-ante cost of capital. We confront our theory with a large dataset of entrepreneurs. We find that differences in beliefs may be (partly) explained by usual determinants put forward in psychology and management literature. We find that firms run by optimists tend to be grow less, die sooner and be less profitable, which we view as a confirmation that our measure of optimism does not proxy high risk-high return projects. Finally, in line with the prediction of our theory, we find that optimists tend to put in more effort, and use more short-term debt to finance their ventures.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
|Date of creation:||Jul 2003|
|Contact details of provider:|| Postal: Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ.|
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820
|Order Information:|| Email: |
When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:3971. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.