The Dynamics of Financial Policies and Group Decisions in Private Firms

We model a startup run by an entrepreneur and a group of co-investors with heterogeneous capital contributions and risk preferences, who together decide on the firm's financial policies, ownership structure and governance. Investors' optimal claims resemble preferred stock with heterogeneous dividend caps, and common stock. The optimal investment policy is a time-varying weighted average of investors' optimal policies and converges to the policy of the least (most) risk averse investor in booms (recessions). Optimal leverage is procyclical. The dynamic financial policies and diversity in equity claims resolve investors' diverging preferences and inability to trade.