Learning, Investment, and Entrepreneurial Survival: A Real Options Approach

35 Pages Posted: 17 Mar 2006

See all articles by Neng Wang

Neng Wang

Columbia University - Columbia Business School, Finance; National Bureau of Economic Research (NBER); Asian Bureau of Finance and Economic Research (ABFER)

Jianjun Miao

Boston University - Department of Economics

Date Written: March 2006

Abstract

Empirical evidence shows that entrepreneurs on average do not earn more than paid employees in terms of the net present value (NPV). One natural question is what makes the entrepreneurs to stay in business. To address this question, we propose a continuous time real options model in which an entrepreneur does not know his 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 NPV is negative. We also show that risk aversion erodes option value and lowers private firm value so that a highly risk averse entrepreneur may exit even when the NPV is positive. In addition, 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.

Keywords: real options, learning, private firm value, survival, precautionary savings, incomplete markets

JEL Classification: D80, D91, G11, E21

Suggested Citation

Wang, Neng and Miao, Jianjun, Learning, Investment, and Entrepreneurial Survival: A Real Options Approach (March 2006). Available at SSRN: https://ssrn.com/abstract=891455 or http://dx.doi.org/10.2139/ssrn.891455

Neng Wang

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
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Asian Bureau of Finance and Economic Research (ABFER) ( email )

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Singapore

Jianjun Miao (Contact Author)

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States
617-353-6675 (Phone)

HOME PAGE: http://people.bu.edu/miaoj

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