Ambiguity, Entrepreneurs and Corporate Finance

Speaker: Lorenzo Garlappi, University of British Columbia

Organized by: Department of Finance

Abstract: Entrepreneurs are often considered engines of growth due to their ability and/or willingness to delve into uncharted economic terrain. We follow a literature that captures this idea with a non-Bayesian multiprior approach to decision making and consider an entrepreneur that faces investment opportunities with ambiguous outcomes. When self-financed, we show that ambiguity may cause entrepreneurs to be cautious in exercising expansion options but reluctant in abandoning pre-existing assets, even when abandonment payoffs are relatively large. With external financing, the optimal financing arrangements critically depends on the way in which ambiguity sensitive preferences are modelled as well as on differences in ambiguity attitudes of financiers and entrepreneurs. Ambiguity can therefore have significantly different, and potentially contradicting, implications on real and financial decisions, depending on the model a researcher uses to accommodate deviations from the Bayesian paradigm of decision making. These findings suggest caution when using ambiguity aversion to “explain" empirically observed phenomena and provide a base for future empirical work that will hed light on how new ambiguous opportunities are in fact handled.