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.
KeywordsConstant Rate of Time PreferencesTime-Inconsistent PreferenceEntrepreneur’s SophisticationIntra-Personal CompetitionStationary Equilibrium
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