Template-Type: ReDIF-Paper 1.0

Author-Name: Junjian Miao
Author-X-Name-First: Junjian
Author-X-Name-Last: Miao
Author-Email: miaoj@bu.edu
Author-Workplace-Name: Department of Economics, Boston University

Author-Name: Neng Wang
Author-X-Name-First: Neng
Author-X-Name-Last: Wang
Author-Email: neng.wang@columbia.edu
Author-Workplace-Name: Columbia Business School

Title: Learning, Investment, and Entrepreneurial Survival

Abstract: Empirical evidence shows that entrepreneurs on average do not earn more than paid em-
ployees in terms of present value. One may ask why individuals what to stay in business
and take entrepreneurial activities. To address this question, we propose a continuous time
real options model in which entrepreneurs do not know their investment quality and learn
about it over time. We show that due to the option value of learning, an entrepreneur
may stay in business even though the net present value (NPV) is negative. We also show
that risk aversion erodes option value and lowers private ¯rm value so that a highly risk
averse entrepreneur may exit even when the NPV is positive. We also show that a more
risk averse or a more pessimistic entrepreneur exits earlier. Finally, the model can generate
the positive relation between wealth and survival duration without liquidity constraints.

Length: 33 pages
Creation-Date: 2005-07
Revision-Date: 
Publication-Status:
File-Format: Application/pdf
File-Function: 
Number: WP2005-015
Classification-JEL: D80, D91, G11, E21
Keywords: real options, learning, private firm value, survival, precautionary savings
Handle: RePEc:bos:macppr:WP2005-015