Working Paper: NBER ID: w20979
Authors: Patrick Bolton; Neng Wang; Jinqiang Yang
Abstract: A risk-averse entrepreneur with access to a profitable venture needs to raise funds from investors. She cannot indefinitely commit her human capital to the venture, which limits the firm’s debt capacity, distorts investment and compensation, and constrains the entrepreneur’s risk-sharing. This puts dynamic liquidity and state-contingent risk allocation at the center of corporate financial management. The firm balances mean-variance investment efficiency and the preservation of financial slack. We show that in general the entrepreneur’s net worth is overexposed to idiosyncratic risk and underexposed to systematic risk. These distortions are greater the closer the firm is to exhausting its debt capacity.
Keywords: No keywords provided
JEL Codes: G3; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Inalienability of human capital (J24) | Distortions in investment and compensation (G19) |
| Distortions in investment and compensation (G19) | Firm's liquidity and risk management policies (G33) |
| Inalienability of human capital (J24) | Firm's debt capacity, investment efficiency, and risk-sharing capabilities (G32) |
| Risk-averse entrepreneur with limited ability to commit human capital (D29) | Overexposure to idiosyncratic risk and underexposure to systematic risk (D81) |
| Firm must balance mean-variance efficiency against preservation of financial slack (D22) | Dynamic liquidity and risk management theory (G19) |
| Abundant liquidity (E51) | Optimize investment policies to approach first-best scenario (G11) |
| Exhausted credit limit (E51) | Preserve liquidity, cut investment and consumption (E21) |