TITLE:
Optimal Operations of Entrepreneurial Firms under Time-Inconsistent Preferences
AUTHORS:
Du Du
KEYWORDS:
Constant Rate of Time Preferences, Time-Inconsistent Preference, Entrepreneur’s Sophistication, Intra-Personal Competition, Stationary Equilibrium
JOURNAL NAME:
Journal of Mathematical Finance,
Vol.14 No.4,
November
27,
2024
ABSTRACT: While standard models in finance assume that an agent possesses a constant rate of time preferences, there is substantial evidence that people are impatient about choices in the short term but are patient when choosing between long-term alternatives. In this paper, we analyze the impact of the resulting time-inconsistent preferences (TIP) on operations of entrepreneurial firms. We differentiate a naive vs. a sophisticated entrepreneur depending on the different expectations regarding her future time-inconsistent behaviors. Relative to the time-consistent benchmark, a naive entrepreneur assigns a lower firm valuation, derives a lower welfare, liquidates the firm earlier, and in general adopts more conservative firm-level policies. Somewhat surprisingly, a time-inconsistent entrepreneur’s sophistication destroys instead of creating values for herself under which she obtains a even lower welfare from the firm. In response, the sophisticated entrepreneur transfers resources from investment to consumption and liquidates the firm even earlier than in the case with a naive entrepreneur.