Entrepreneurial Optimism Research Articles

Financial Contracting with Optimistic Entrepreneurs

Optimistic beliefs are a source of nonpecuniary benefits for entrepreneurs that can explain the “Private Equity Puzzle.” This paper looks at the effects of entrepreneurial optimism on financial contracting. When the contract space is restricted to debt, we show the existence of a separating equilibrium in which optimists self-select into short-term debt and realists into long-term debt. Long-term debt is optimal for a realist entrepreneur as it smooths payoffs across states of nature. Short-term debt is optimal for optimists for two reasons: (i) “bridging the gap in beliefs” by letting the entrepreneur take a bet on his project’s success, and (ii) letting the investor impose adaptation decisions in bad states. We test our theory on a large data set of French entrepreneurs. First, in agreement with the psychology literature, we find that biases in beliefs may be (partly) explained by individual characteristics and tend to persist over time. Second, as predicted by our model, we find that short-term debt is robustly correlated with “optimistic” expectation errors, even controlling for firm risk and other potential determinants of short-term leverage.

Risk, Uncertainty and Optimism in Venture Capital Relationships

We develop a dynamic, structural model to quantitatively assess the effects of risk, uncertainty and asymmetric beliefs about project quality on the characteristics of venture capital relationships. We estimate the model parameters with data about the distributions of total investments, payoffs, risks and returns of venture capital projects. Entrepreneurial optimism mitigates the agency costs of risk-sharing between venture capitalists (VCs) and entrepreneurs (ENs) by over 20\% and significantly enhances the VC's expected payoffs. The EN optimism premium implied by the data explains the huge discrepancy between the discount rates used by VCs ($\sim$ 40\%), which adjust for optimistic payoff projections by ENs, and the average expected return of VC projects ($\sim$ 15\%). Consistent with observed contractual structures, the equilibrium dynamic contracts feature both equity-like and debt-like components for the VC and progressive vesting of the EN's stake. The duration, project value and the VC's expected payoff all increase with the project's transient risk but decrease with its intrinsic risk.

The Effects of Experience on Entrepreneurial Optimism and Uncertainty

This paper develops an occupational choice model in which entrepreneurs, who are initially uncertain about their true talent, learn from experience. As a consequence, both optimistic bias in talent beliefs and uncertainty diminish with experience. The model gives rise naturally to a heteroscedastic probit estimator of occupational choices, in contrast to the commonly used homoscedastic estimator. The model is applied to British data on self‐employment and optimism for the period 1984–99. The empirical analysis supports the main propositions of the model: principally, entrepreneurs are found to be more optimistic than employees, and both optimism and uncertainty diminish with experience.

Financial Contracting with Optimistic Entrepreneurs: Theory and Evidence

This paper looks at the effects of entrepreneurial optimism on financial contracting and corporate performance. Optimism may increase effort, but is bad for adaptation decisions as the entrepreneur underweights negative information. The first-best contract with an optimist uses contigencies for two distinct purposes: (1) bridging the gap in beliefs by letting the entrepreneur take a bet on his project's success, and (2) imposing adaptation decisions in bad states. When the contract space is restricted to debt, there may exist a separating equilibrium where optimists self-select in short-term debt and realists in long-term debt. We confront our theory to a large dataset of entrepreneurs. First, we find that differences in beliefs may be (partly) explained by usual determinants put forward in psychology and management literature. Second, in line with the two main predictions of our model, we find that (1) optimists tend to borrow more short term and (2) those optimists that borrow more short term perform better. Last, we find that firms run by optimists tend to grow less, die sooner and be less profitable, which we view as a confirmation that our measure of optimism does not proxy high risk - high return projects.

Industrial Mobility in the Turin Metropolitan Area, 1961-77

A survey of 410 plant relocations and branch plant creations in the Turin Metropolitan Area is used to formulate a model of the timing and spatial incidence of manufacturing change. Entrepreneurs' expectations about growth or decline are seen as determining the rate of anticipated movement but land use policies and the state of industrial relations may act as constraints on the process. The actual rates of movement over the period 1961-77 are regressed against a measure of entrepreneurial optimism or pessimism, the rate of change of national consumption and the rate of investment.