Entrepreneurial finance with equity-for-guarantee swap and idiosyncratic risk

Haomao Wang, Zhaojun Yang, Hai Zhang

Research output: Contribution to journalArticle

14 Citations (Scopus)

Abstract

We consider a risk-averse entrepreneur who invests in a project with idiosyncratic risk. In contrast to the literature, we assume the entrepreneur is unable to get a loan from a bank directly because of the low creditability of the entrepreneur and so an innovative financial contract, named equity-for-guarantee swap, is signed among a bank, an insurer, and the entrepreneur. It is shown that the new swap leads to higher leverage, which brings more diversification and tax benefits. The new swap not only solves the problems of financing constraints, but also significantly improves the welfare level of the entrepreneur. The growth of welfare level increases dramatically with risk aversion index and the volatility of idiosyncratic risk.
LanguageEnglish
Pages863-871
Number of pages9
JournalEuropean Journal of Operational Research
Volume241
Issue number3
DOIs
Publication statusPublished - 16 Mar 2015
Externally publishedYes

Fingerprint

Swap
Equity
Finance
Welfare
Risk Aversion
Diversification
Tax
Signed
Leverage
Volatility
Taxation
Guarantee
Swaps
Entrepreneurial finance
Entrepreneurs
Idiosyncratic risk
Banks

Keywords

  • finance
  • borrowing constraints
  • equity-for-guarantee swap
  • capital structure
  • cash out option

Cite this

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Entrepreneurial finance with equity-for-guarantee swap and idiosyncratic risk. / Wang, Haomao; Yang, Zhaojun; Zhang, Hai.

In: European Journal of Operational Research, Vol. 241, No. 3, 16.03.2015, p. 863-871.

Research output: Contribution to journalArticle

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AB - We consider a risk-averse entrepreneur who invests in a project with idiosyncratic risk. In contrast to the literature, we assume the entrepreneur is unable to get a loan from a bank directly because of the low creditability of the entrepreneur and so an innovative financial contract, named equity-for-guarantee swap, is signed among a bank, an insurer, and the entrepreneur. It is shown that the new swap leads to higher leverage, which brings more diversification and tax benefits. The new swap not only solves the problems of financing constraints, but also significantly improves the welfare level of the entrepreneur. The growth of welfare level increases dramatically with risk aversion index and the volatility of idiosyncratic risk.

KW - finance

KW - borrowing constraints

KW - equity-for-guarantee swap

KW - capital structure

KW - cash out option

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