Seminar: Pierre-Yves Yanni, Swiss Institute of Technology

Title: Coarse Reputation and Entrepreneurial Risk Choice.

I analyze a model of anonymous debt markets in which investors finance entre-preneurs and only observe whether they have defaulted in the past. I show that there is a dynamic complementarity in risk choice: incentives to choose the safe over the risky project in the current period are stronger (weaker) if entrepreneurs ran safe (risky) projects in the past and also if they are expected to run safe (risky) projects in the future. Reputation concerns can induce entrepreneurs to be too conservative: the economy becomes stuck in an ine¢ cient equilibrium in which entrepreneurs choose safe projects over risky ones because they are excluded from financial markets if they fail. In this case a transition to the socially optimal risky equilibrium can be achieved by taxing entrepreneurs and subsidizing investment in a way that balances the budget and is a Pareto improvement.