Entrepreneurial Finance and Non-diversifiable Risk
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Chen_Entrepreneurial Finance.pdf
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Author(s)
Chen, Hui
Miao, Jianjun
Wang, Neng
Date Issued
November 2010
Journal
Review of Financial Studies
Publisher
Oxford University Press
Citation
Chen, H., J. Miao, and N. Wang. “Entrepreneurial Finance and Nondiversifiable Risk.” Review of Financial Studies 23.12 (2010) : 4348-4388.
Version
Final published version
Abstract
We develop a dynamic incomplete-markets model of entrepreneurial firms, and demonstrate the implications of nondiversifiable risks for entrepreneurs' interdependent consumption, portfolio allocation, financing, investment, and business exit decisions. We characterize the optimal capital structure via a generalized tradeoff model where risky debt provides significant diversification benefits. Nondiversifiable risks have several important implications: More risk-averse entrepreneurs default earlier, but choose higher leverage; lack of diversification causes entrepreneurial firms to underinvest relative to public firms, and risky debt partially alleviates this problem; and entrepreneurial risk aversion can overturn the risk-shifting incentives induced by risky debt. We also analytically characterize the idiosyncratic risk premium.
MIT Department
Sloan School of Management
Terms of Use
Article is made available in accordance with the publisher's policy and may be subject to US copyright law. Please refer to the publisher's site for terms of use.
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DOI of Published Version
https://doi.org/10.1093/rfs/hhq122
