Entrepreneurs, legal institutions and firm dynamics

Neus Herranz, Stefan Krasa and Anne P. Villamil ()
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Neus Herranz: University of Illinois
Anne P. Villamil: University of Iowa

Economic Theory, 2017, vol. 63, issue 1, No 11, 263-285

Abstract: Abstract This paper assesses the impact of legal institutions on firm dynamics in a model where entrepreneurs have heterogeneous risk aversion, credit constraints and may default. Entrepreneurs choose firm size, capital structure, consumption, default and whether to incorporate. We find that less risk-averse entrepreneurs tend to incorporate while more risk-averse entrepreneurs do not; this occurs because leaving some personal assets exposed by not incorporating allows more risk-averse borrowers to credibly commit to lower default rates. We show that incorporation is determined by two effects: the standard effect that bankruptcy insures low firm returns and a new “scale effect”—more risk-averse entrepreneurs run smaller firms and default more often. The more risk-averse choose to leave some personal assets unshielded in bankruptcy due to a commitment problem that dominates the value of insurance. The less risk-averse run larger firms, default less and incorporate.

Keywords: Entrepreneur; Legal environment; Incorporated; Unincorporated; Endogenous default; Bankruptcy; Commitment; Insurance; Firm size; Risk aversion; Heterogeneity; Credit constraints; Capital structure; Debt (search for similar items in EconPapers)
JEL-codes: D92 E01 G33 G38 L25 L26 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (5)

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Working Paper: Entrepreneurs, Legal Institutions and Firm Dynamics (2009)
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DOI: 10.1007/s00199-016-1026-8

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