An Economic Theory with a Formal-Econometric Test of Its Empirical Relevance

The paper contains five parts—a theory about entrepreneurial choice under uncertainty, a formal econometric structure for a test, the test, an appraisal of the test, and a description of the data generating process. Here, an entrepreneur is an individual who manages a firm that produces one commodity with labor, an intermediate good, and capital. He pays dividends to shareholders, invests in bonds and capital, and has an n-period planning horizon. Conditioned on the values of current-period prices, the entrepreneur aims to maximize the expected value of a utility function that varies with the dividends he pays each period and with his firm’s balance sheet variables at the end of the planning horizon. The test comprises a family of trials of theorems that I derive from the axioms of the theory part of the formal econometric structure. In the test, the theorems are appraised for their empirical relevance in an empirical context, where each one of a random sample of four hundred entrepreneurs has chosen the first-period part of his optimal n-period expenditure plan. My formal econometric arguments demonstrate that the theorems pass all the trials. At the end, I show that my formal econometric results imply that the theory is empirically relevant.