Macroeconomic Conditions, Persistent Preference Shocks, and Corporate Management

Abstract

Macroeconomic conditions affect multiple dimensions that are related to the operation of an entrepreneurial firm. Through a multi-regime dynamic stochastic model, we show that this simple observation has a wide range of empirical implications for corporations. Notably, we show that the entrepreneur invests less, assigns a lower value to firm-held capital, and liquidates the firm earlier when the macroeconomic condition is bad, and this is particularly true when she is more risk averse. Somewhat surprisingly, a bad economic condition or a higher degree of risk aversion may encourage consumption, but this effect can be largely smoothed out once we allow for reasonable macroeconomic dynamics. The duration of economic recessions has particularly large impact on the entrepreneur’s welfare and the implied business liquidation. While raising entrepreneur’s risk aversion induces more conservative policies during good times, its effects during the bad times are mixed, which depend on the firm’s financial status.