Risk Aversion, Managerial Reputation, and Debt–Equity Conflict

When a firm finances new project by issuing debt, it has an incentive to invest in excessively high-risk projects because shareholders enjoy all the benefits case is successful but have limited liability when fails. Anticipating such behavior, creditors may require higher interest rate or even refuse provide capital. This debt–equity conflict alleviated fact that most investment decisions are made risk-averse managers who not as well diversified shareholders. paper investigates firms which unobservable degree of risk averseness. Since managerial averseness desirable quality, asymmetric information makes undertake actions increase market’s perception them being highly risk-averse. Consequently, reputation building leads lower number undertaken. compares entrepreneurial economy, sole owners firms, with corporate hired Using overlapping generations model, this shows can partially resolve and improve efficiency both economies; however, improvement larger economy.