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Investment and capital structure decisions under time-inconsistent preferences

  • Masaaki Kijima


    (Graduate School of Social Sciences, Tokyo Metropolitan University)

  • Yuan Tian


    (Faculty of Economics, Ryukoku University)

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    Based on a continuous-time model of quasi-hyperbolic discounting, this paper provides an analytically tractable framework of entrepreneurial firms’ investment and capital structure decisions with time-inconsistent preferences. We show that the impact of time-inconsistent preferences depends not only on the financing structures (all-equity financing or debt-equity financing), but also on the entrepreneurs’ belief regarding their future timeinconsistent behavior (sophisticated or naive). Time-inconsistent preferences delay investment under both all-equity financing and debt-equity financing. However, the impact is weakened under debt-equity financing, because debt financing increases the payoff value upon investment and accelerates investment. Naive entrepreneurs invest later and default earlier than sophisticated entrepreneurs, leading to a shorter operating period. Moreover, we find that naive entrepreneurs may choose higher leverage, while sophisticated entrepreneurs always choose lower leverage, compared to the time-consistent benchmark. These results support the empirical findings in entrepreneurial finance.

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    Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 858.

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    Date of creation: Apr 2013
    Date of revision:
    Handle: RePEc:kyo:wpaper:858
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