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Wasted Ideas: Limited Diversification and the Rise of Intangibles 

Job Market Paper* 

Abstract

I model entrepreneurial investments when intangible capital is riskier than tangible capital. Limited diversification refers to inability of risk-averse entrepreneurs to fully diversify idiosyncratic intangible risk by either ownership arrangements or insurance. Entrepreneurs demand tangible capital for two more reasons beyond its productive role: (i) collateral service and (ii) hedging value. I find poor undiversified entrepreneurs tilt toward tangibles their capital mix to hedge against intangible risk. Wealthier undiversified entrepreneurs increasingly self-insure with cash due to diminishing marginal returns. In my quantitative analysis, limited diversification is a key driver of the results. It reduces aggregate intangible-to-tangible ratio by 8p.p, intangibles by 11% and output by 4% relative to fully diversified entrepreneurs. These shortfalls increase as production becomes more intensive in intangible inputs.

* (draft available upon request)