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Entrepreneurs, Risk Aversion and Dynamic Firms

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  • Neus Herranz,
  • Stefan Krasa,
  • Anne P. Villamil

Abstract

This paper conducts a theoretical and quantitative analysis of how entrepreneurs choose firm size, capital structure, default, and owner consumption to manage firm risk, including how these choices change with risk aversion. We decompose an entrepreneur’s default decision into three elements: the fraction of firm debt; the potential reduction in personal consumption from losing the firm; and the ratio of personal wealth to firm scale, which determines an entrepreneur’s ability to inject personal funds to continue operation. Data from the Survey of Small Business Finances is used to calibrate the model and estimate entrepreneur risk aversion. We determine the evolution of entrepreneur net worth, consumption, and firm assets over time. We find that many entrepreneurs have lower net worth and consumption than non-entrepreneurs with the same preferences, but the densities of the distributions of consumption and net-worth have wide upper tails. Thus, entrepreneurship can be a path toward great wealth and high consumption for the top quantiles of entrepreneurs.

Suggested Citation

  • Neus Herranz, & Stefan Krasa, & Anne P. Villamil, 2013. "Entrepreneurs, Risk Aversion and Dynamic Firms," Centre for Growth and Business Cycle Research Discussion Paper Series 189, Economics, The University of Manchester.
  • Handle: RePEc:man:cgbcrp:189
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    File URL: http://hummedia.manchester.ac.uk/schools/soss/cgbcr/discussionpapers/dpcgbcr189.pdf
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    References listed on IDEAS

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    1. Hui Chen & Jianjun Miao & Neng Wang, 2010. "Entrepreneurial Finance and Nondiversifiable Risk," Review of Financial Studies, Society for Financial Studies, vol. 23(12), pages 4348-4388, December.
    2. Kartik B. Athreya, 2004. "Shame as it ever was : stigma and personal bankruptcy," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 90(Spr), pages 1-19.
    3. Andrew Glover, 2010. "Bankruptcy, Incorporation, and the Nature of Entrepreneurial Risk," 2010 Meeting Papers 1010, Society for Economic Dynamics.
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    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. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
    7. Gropp, Reint & Boissay, Frédéric, 2007. "Trade credit defaults and liquidity provision by firms," Working Paper Series 753, European Central Bank.
    8. Galina Vereshchagina & Hugo A. Hopenhayn, 2009. "Risk Taking by Entrepreneurs," American Economic Review, American Economic Association, vol. 99(5), pages 1808-1830, December.
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    Cited by:

    1. Federico Esposito, 2016. "Risk Diversification and International Trade," 2016 Meeting Papers 302, Society for Economic Dynamics.

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