Decisive Entrepreneurs and Cautious Investors¤

Entrepreneurs may undertake investments when returns cannot be precisely evaluated: they are decisive. Lenders may require high compensation to place funds in those ventures: they are cautious. We analyze optimal ̄nancing contracts between entrepreneurs and lenders. Decisiveness and cautiousness are characterized using Bewley's (1986) incomplete preferences framework. Preferences are represented by a utility function and a set of probability distributions. Suppose a project's expected net return is positive for some distributions and negative for others. Then, invest and leave money in the bank are non comparable alternatives. Undertaking the venture is a decisive action: entrepreneurship makes it attractive. Cautiousness corresponds to leaving money in the bank unless there is an alternative with higher expected return for all distributions. Given the optimal contract, the entrepreneur can invest only if she owns some assets to use as collateral. Cautious lenders require too high a remuneration; collateral has a safe value and lowers their demands. All available assets are used as collateral: self ̄nancing is the preferred source of funds. When there are two lenders with di®erent levels of cautiousness, the optimal contract gives the less cautious a stake in the project, and the more cautious a safer contract. ¤I received many useful comments from Truman Bewley, Uli Hege, June K. Lee, Frederic Palomino, Matthew Ryan and seminar participants at Tilburg and Yale universities. I am especially indebted to Ben Polak for convincing me that some of my previous thoughts on this topic were hopelessly wrong. As usual, all errors are mine.