Abstract
This paper uses Survey of Small Business Finance data to better understand how the owners of small firms use decisions about legal organization, firm size, capital structure, and owner investment in the firm to manage firm risk. The main findings are: Firms with unlimited liability are smaller, both when measured by assets and number of employees, and tend to be less leveraged than those whose owners limit personal exposure to firm liabilities. Entrepreneurs tend to hold largely undiversified positions by investing heavily in their firms, and this does not differ appreciably by legal organization. The percentage of firms with limited liability has remained virtually constant through time, although within this group there is a trend toward hybrid legal organizations with beneficial tax treatment. We estimate return on assets and find that entrepreneurship is a very risky undertaking, with high upside gain. The possibility of high future returns helps explain the coexistence of a large percentage of firms with negative equity and low default rates. The shape of the return distribution and limited liability interact; the option to declare bankruptcy shields owners from personal loss in the lower tail of the distribution while preserving the potential for significant firm returns in the upper tail.
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We thank Joanna Alexopoulos, George Deltas, Cristina De Nardi, Kevin Williams and participants at the 2007 SAET meetings in Kos for helpful discussions. This work was completed while Villamil was the Hallsworth Visiting Professor at the University of Manchester. We gratefully acknowledge financial support from National Science Foundation grant SES-031839, NCSA computation grant SES050001, the Center for Private Equity Research at the University of Illinois, Kauffman Foundation grant 20061258 and the Academy for Entrepreneurial Leadership. Any opinions, findings, and conclusions or recommendations expressed in this paper are those of the authors and do not necessarily reflect the views of the National Science Foundation or any other organization.
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Herranz, N., Krasa, S. & Villamil, A.P. Small firms in the SSBF. Ann Finance 5, 341–359 (2009). https://doi.org/10.1007/s10436-008-0118-2
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DOI: https://doi.org/10.1007/s10436-008-0118-2