Entrepreneurial Finance and Non-diversifiable Risk / Hui Chen, Jianjun Miao, Neng Wang.

Format:

Book

Author/Creator:

Chen, Hui.

Contributor:

National Bureau of Economic Research.

Miao, Jianjun.

Wang, Neng.

Series:

Working Paper Series (National Bureau of Economic Research) no. w14848.

NBER working paper series no. w14848

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2009.

Summary:

Entrepreneurs face significant non-diversifiable business risks. We build a dynamic incomplete markets model of entrepreneurial finance to demonstrate the important implications of nondiversifiable risks for entrepreneurs' interdependent consumption, portfolio allocation, financing, investment, and business exit decisions. The optimal capital structure is determined by a generalized tradeoff model where leverage via risky non-recourse debt provides significant diversification benefits. More risk-averse entrepreneurs default earlier, but also choose higher leverage, even though leverage makes his equity more risky. Non-diversified entrepreneurs demand both systematic and idiosyncratic risk premium. Cash-out option and external equity further improve diversification and raise the entrepreneur's valuation of the firm. Finally, entrepreneurial risk aversion can overturn the risk-shifting incentives induced by risky debt.

Notes:

Print version record

April 2009.