Reconceptualizing Entrepreneurial Exit: Divergent Exit Routes and Their Drivers

We develop a conceptual model of entrepreneurial exit which includes exit through liquidation and firm sale for both firms in financial distress and firms performing well. This represents four distinct exit routes. In developing the model, we complement the prevailing theoretical framework of exit as a utility-maximizing problem among entrepreneurs with prospect theory and its recent applications in liquidation of investment decisions. We empirically test the model using two Swedish databases which follow 1,735 new ventures and their founders over eight years. We find that entrepreneurs exit from both firms in financial distress and firms performing well. In addition, commonly examined human capital factors (entrepreneurial experience, age, education) and failure-avoidance strategies (outside job, reinvestment) differ substantially across the four exit routes, explaining some of the discrepancies in earlier studiesEntrepreneurial Exit; Prospect Theory; Human Capital

Investment Behavior under Ambiguity: The Case of Pessimistic Decision Makers

We define pessimistic, respectively optimistic, investors as CEU (Choquet expected utility) decision makers who update their pessimistic, respectively optimistic, beliefs according to a pessimistic (Dempster-Shafer), respectively optimistic, update rule. This paper then demonstrates that, in contrast to optimistic investors, pessimistic investors may strictly prefer investing in an illiquid asset to investing in a liquid asset. Key to our result is the dynamic inconsistency of CEU decision making, implying that a CEU decision maker ex ante prefers a different strategy with respect to prematurely liquidating an uncertain long-term investment project than after learning her liquidity needs. Investing in an illiquid asset then serves as a commitment device guaranteeing an ex ante favorable outcome.

An Agency Cost Analysis of the Wrongful Trading Provisions: Redistribution, Perverse Incentives and the Creditors' Bargain

Previous work on the wrongful trading provisions of the Insolvency Act 1986 (s. 214) has been content with description, or with statutory construction. This paper employs the tools of agency theory and the creditors' bargain heuristic to analyse the need for these provisions, their structure, role, and effect. It examines why those interested in the company's undertaking would demand and accept a s. 214-type duty. The analysis reveals that the duty would not be equally relevant for all types of companies, and that the influence of the market for managerial labour ensures most s. 214 actions are likely to be brought against directors of closely-held companies, and against shadow directors. The analysis, by pointing out that security plays a role similar to s. 214 itself, also justifies a recent Court of Appeal decision which precludes secured creditors from any recoveries under that section. Finally, the incentives created by the provisions for the managers of both healthy and distressed companies are examined. It is suggested that these incentives are generally socially efficient

Implementing Behavioral Concepts into Banking Theory: The Impact of Loss Aversion on Collateralization

In standard bank theoretic models agents are assumed to be fully rational expected utility maximizers. This fact ignores the huge amount of evidence for anomalies in human behavior found by psychologists. In this paper we argue that the implementation of behavioral concepts into banking theory might increase the predictive power of the models. As an example we consider a loan market and discuss the impact of loss aversion on the degree of collateralization in equilibrium. The very well established concept loss aversion predicts entrepreneurs to pay much more attention to the potential loss of some of their initial wealth due to a collateralized loan than they would do as expected utility maximizers. This results in a higher effort choice which in turn increases the success probability of the loan financed project. Optimal levels of collateralization are derived for different degrees of loss aversion and the problem of private information about the degree of loss aversion is addressed. It is shown that in specific situations banks can offer self selecting pairs of contracts that costlessly eliminate the private information problem.

Closing down the Farm: An Experimental Analysis of Disinvestment Timing

Agrarian structures are often characterized by some kind of economic inertia. It is particularly puzzling why unprofitable farms persist over time instead of being sold. In this paper we analyze the exit decision of farmers using the real options approach. The validity of the real options theory is assessed by means of laboratory experiments. Our results show that real options models are able to predict actual disinvestment decisions better than traditional investment theory. Nevertheless, the observed disinvestment reluctance was even more pronounced as predicted by theory. This finding suggests the inclusion of bounded rationality into normative disinvestment models.Disinvestment, Real Options, Experimental Economics, Agricultural Finance, Farm Management, C91, D81, D92,

China's new corporate rescue laws: perspectives and principles

This article considers the new corporate insolvency legislation that came into force in China in June 2007. This law is part of a remarkable transformation in the Chinese economy in recent years. Significant numbers of ailing state owned enterprises have been reformed and subjected to hard budgetary constraints, while the private sector has grown dramatically. Market forces play a greater role, whereas the economy was previously tightly controlled by the state. These changes, together with pressures arising from external bodies such as the European Union, led to an urgent need for the adoption of the revised insolvency law, which has at its heart corporate rescue procedures. This article considers the content of this new law, the background to it, and also assesses the prospects for its operation. In particular attention is paid to the level of scope for state interference in the operation of the law

The Philosophy of Midcentury Corporation Statutes

Professor Katz, in a Symposium issue for another journal, theorizes about the purpose of corporation statutes. At its heart, the theory of business enterprise attempts to delineate the areas of risk, control, and profit, that partners can allocate amongst themselves and to define defaults when these areas are not allocated. Statutes are approached three ways: enabling, which gives ample freedom to corporations to structure themselves; mix, which provides a statutory structure but still relies on corporate responsibility; and a paternal responsibility structure, which limits what a corporation can do; and a fourth approach, a social responsibility theory not yet reflected in statutes, that advocates that corporations should include the public good when making decisions. Professor Katz then considers various statutory topics within the framework of the three approaches. Most of the statutes that Professor Katz examines fall into the first theory, enabling statutes; North Carolina statutes are the only that apply the other two theories. Interestingly, the dominant enabling theory is one that has been under attack for almost one hundred years; and the new revolution of statutes (corporate gifts to charity) will not have the impact others think it will, but rather will serve as an impetus to ensure that there is still a means by which to punish corporations

Statutory erosion of secured creditors' rights: some insights from the United Kingdom

As the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11 considers the state of business bankruptcy in this country, the narrative on chapter 11 is well-established and oft-repeated. According to this narrative, whereas in the past firms filing for chapter 11 came into the bankruptcy process with at least some unencumbered assets, modern firms tend to have capital structures that are entirely consumed by multiple layers of secured debt. Moreover, as secured creditors have come to dominate capital structures, conventional wisdom has it that they have “captured” chapter 11 to the detriment of unsecured creditors. This development has justifiably troubled many scholars on both efficiency and distributional grounds. However, it remains an open question whether the perceived downsides of secured creditor control can be satisfactorily addressed through bankruptcy law reform. In this Article, Professor Walters examines English attempts to use bankruptcy law to adjust the priority and control rights of secured creditors with the aim of improving the welfare of unsecured creditors. The Article starts from the premise that lenders that are powerful enough to bargain for superior control and priority rights inside or outside of bankruptcy will be equally capable of adjusting to legal changes that affect, or are perceived as affecting their interests. Four ways in which lenders will adjust to “adverse” bankruptcy reform are identified: (i) metabargaining; (ii) adjustments to prebankruptcy behavior; (iii) transactional innovation; and (iv) “shape shifting”. In Parts II and III, the Article then illustrates how English lenders have successfully adjusted to statutory erosion of their priority rights through transactional innovation and to statutory attempts to curb their control rights through “shape shifting”. Walters’ conclusion on the efficacy of bankruptcy law reform is cautionary and skeptical. He assesses English attempts to improve the position of unsecured creditors by dampening the rights of secured creditors as a failed conceit

Destructive Effects of Constructive Ambiguity in Risky Times

Unclear bailout policy, underinvestment and calls for bankers? responsibility are some of the observations from the recent financial crisis. The paper explains underinvestment as an inefficient equilibrium. Under ambiguous bailout policy agents suffer from a lack of information with regards to the insolvency resolution methods. Beliefs of bankers regarding whether an insolvent bank is liquidated, may differ from those of depositors even if bankers and depositors possess absolutely symmetric information about the economy. It is shown that such an asymmetry in beliefs results in underinvestment if the investment climate is characterized by high aggregate risk. The paper suggests policy implications aimed at the reduction of anxiety of agents and at aligning their beliefs to restore efficiency

Holding on for too long? An experimental study on inertia in entrepreneurs’ and non-entrepreneurs’ disinvestment choices

Disinvestment, in the sense of project termination and liquidation of assets including the cession of a venture, is an important realm of entrepreneurial decision-making. This study presents the results of an experimental investigation modeling the choice to disinvest as a dynamic problem of optimal stopping in which the patterns of decisions are analyzed with entrepreneurs and non-entrepreneurs. Our experimental results reject the standard net present value approach as an account of observed behavior. Instead, most individuals seem to understand the value of waiting. Their choices are weakly related to the disinvestment triggers derived from a formal optimal stopping benchmark consistent with real options reasoning. We also observe a pronounced ‘psychological inertia’, i.e., most individuals hold on to a losing project for even longer than real options reasoning would predict. The study provides evidence for entrepreneurs and non-entrepreneurs being quite similar in their behavior.Real-Options, Disinvestment, Exit Behavior, Experimental Economics, Agribusiness, Agricultural and Food Policy, Agricultural Finance, Institutional and Behavioral Economics,