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How Does Owners? Exposure to Idiosyncratic Risk Influence the Capital Structure of Private Companies?

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Author Info
Müller, Elisabeth

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Abstract

This paper identifies the entrepreneur?s exposure to idiosyncratic risk as an important determinant of the capital structure of private companies. The exposure to idiosyncratic risk is approximated by the share of personal net worth invested in one company (SNWI). Exposure to idiosyncratic risk increases cost of equity capital since higher equity returns are required as compensation. This makes bank financing more attractive. We find that SNWI increases the demand for new bank loans whereas we cannot identify an effect on the supply. Equilibrium values of leverage increase significantly in SNWI but there is no effect on the equilibrium interest rate.

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Publisher Info
Paper provided by ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research in its series ZEW Discussion Papers with number 05-14.

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Date of creation: 2005
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Handle: RePEc:zbw:zewdip:2904

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Related research
Keywords: entrepreneurial investment; capital structure; underdiversification; private companies;

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Find related papers by JEL classification:
G30 - Financial Economics - - Corporate Finance and Governance - - - General
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure

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  1. Chittenden, Francis & Hall, Graham & Hutchinson, Patrick, 1996. " Small Firm Growth, Access to Capital Markets and Financial Structure: Review of Issues and an Empirical Investigation," Small Business Economics, Springer, vol. 8(1), pages 59-67, February.
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    Other versions:
  4. Ilya A. Strebulaev, 2004. "Do Tests of Capital Structure Theory Mean What They Say?," Econometric Society 2004 North American Summer Meetings 646, Econometric Society. [Downloadable!]
  5. Ken Cavalluzzo & John Wolken, 2002. "Small business loan turndowns, personal wealth and discrimination," Finance and Economics Discussion Series 2002-35, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  6. Marianne P. Bitler & Tobias J. Moskowitz & Annette Vissing-Jørgensen, 2005. "Testing Agency Theory with Entrepreneur Effort and Wealth," Journal of Finance, American Finance Association, vol. 60(2), pages 539-576, 04. [Downloadable!] (restricted)
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  8. Müller, Elisabeth, 2004. "Underdiversification in Private Companies : Required Returns and Incentive Effects," ZEW Discussion Papers 04-29, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research. [Downloadable!]
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  11. Petersen, Mitchell A & Rajan, Raghuram G, 1994. " The Benefits of Lending Relationships: Evidence from Small Business Data," Journal of Finance, American Finance Association, vol. 49(1), pages 3-37, March. [Downloadable!] (restricted)
  12. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June. [Downloadable!] (restricted)
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  14. Fan, Wei & White, Michelle J, 2003. "Personal Bankruptcy and the Level of Entrepreneurial Activity," Journal of Law & Economics, University of Chicago Press, vol. 46(2), pages 543-67, October.
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