Entrepreneurial investment and financing with third-party guarantees under present-biased preferences

Liu Gan, Xin Xia and Mingyu Xu

Finance Research Letters, 2023, vol. 55, issue PA

Abstract: Some guarantors in China promise to make equity investments to finance entrepreneurial firms’ future expansion investment, beyond guaranteeing their existing bank debt. This paper employs a real options model to study entrepreneurial firms’ expansion investment decisions, the valuation of the fair guarantee premium, and guarantors’ equity investment policies when entrepreneurs exhibit present-biased preferences. We show that as the degree of present bias increases, entrepreneurial firms invest later and guarantors make smaller equity investments. We demonstrate an inverted U-shaped relationship between the fair guarantee premium and the degree of present bias. Finally, present-biased entrepreneurs’ optimal capital structure decisions are discussed.

Keywords: Expansion investment; Equity investment; Fair guarantee premium; Present-biased preferences (search for similar items in EconPapers)
JEL-codes: G13 G32 G33 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:55:y:2023:i:pa:s1544612323002143

DOI: 10.1016/j.frl.2023.103841

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