Optimistic beliefs are a source of nonpecuniary benefits for entrepreneurs that can explain the “Private Equity Puzzle.” This paper looks at the effects of entrepreneurial optimism on financial contracting. When the contract space is restricted to debt, we show the existence of a separating equilibrium in which optimists self-select into short-term debt and realists into long-term debt. Long-term debt is optimal for a realist entrepreneur as it smooths payoffs across states of nature. Short-term debt is optimal for optimists for two reasons: (i) “bridging the gap in beliefs” by letting the entrepreneur take a bet on his project’s success, and (ii) letting the investor impose adaptation decisions in bad states. We test our theory on a large data set of French entrepreneurs. First, in agreement with the psychology literature, we find that biases in beliefs may be (partly) explained by individual characteristics and tend to persist over time. Second, as predicted by our model, we find that short-term debt is robustly correlated with “optimistic” expectation errors, even controlling for firm risk and other potential determinants of short-term leverage.

We model an organization as a two-agent hierarchy: an informed Decision Maker in charge of selecting projects and a (possibly) uninformed Implementer in charge of their execution. Both have intrinsic preferences over projects. This paper models the costs and benefits of divergence between their preferences, that is, dissent within the organization. Dissent is useful to (1) foster the use of objective (and sometimes private) information in decision making and (2) give credibility to the Decision Maker's choices. However, dissent comes at the cost of hurting the Implementer's intrinsic motivation, thereby impairing organizational efficiency. We show that dissent can be optimal, in particular, when information is useful and uncertainty is high. Moreover, dissent remains an optimal organizational form even when Implementers can choose their employer or when Decision Makers have real authority over hiring decisions.

The recent turmoil on credit markets has drawn attention to the risk management function. On many trading oors around the world, traders have been writing insurance against rare events: examples include keeping long positions on CDO tranches or selling protection against default (CDS). In normal times, it is the role of risk management to ensure that the received insurance premia are not entirely considered as income, and that enough capital is set aside to protect the institution against the risk that it is taking. In the period that led to the current crisis, however, risk management has failed to play this role.1 This is particularly troubling as the nance industry is one that has embraced the notion of using counter-powers to limit risk and the importance of dissent within organizations. For instance, the Head of Risk Management at KfW, a German bank, argued for the superiority of having a “central” risk management function, independent of the business units: “The great advantage [of central risk management] is the absence of conict of interest. The central risk management is not driven by the market. We look at the business from a different angle; we are not involved at the personal level.” (quoted by PriceWaterHouseCoopers, 2007). The purpose of this paper is to study when such virtuous organizational design may fail. We rst propose a model of risk management. Following Augustin Landier et al (forthcoming), we model the trading oor as a simple hierarchy. The role of the trader (T) is to select an asset to invest in, while the risk manager (RM) can decide to approve, or not. Due to his