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Profit Maximization and the Market Selection Hypothesis

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Author Info
Dutta, Prajit K
Radner, Roy
Abstract

We examine the proposition that competitive firms must behave as if they were maximizing profits; otherwise they would go bankrupt, or even fail to be financed in a competitive capital market. We investigate a model in which an entrepreneur raises funds for a risky enterprise on a competitive capital market, by offering a "dividend policy" based on the realized (stochastic) flow of earnings. We show that an entrepreneur who maximizes the expected sum of discounted dividends is sure to fail in finite time. On the other hand, many other behaviours yield positive expected profits and are able to attract investment funds, and yet result in a positive probability of surviving forever. As a consequence, if new firms have sufficiently diverse behaviours, then even if there is a constant stream of new entrants, after a long time practically all of the surviving firms will not have been maximizing profits. Copyright 1999 by The Review of Economic Studies Limited.

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Publisher Info
Article provided by Blackwell Publishing in its journal Review of Economic Studies.

Volume (Year): 66 (1999)
Issue (Month): 4 (October)
Pages: 769-98
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Handle: RePEc:bla:restud:v:66:y:1999:i:4:p:769-98

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  1. Ronald W. Anderson, 2002. "Capital structure, firm liquidity and growth," Research series 200205-8, National Bank of Belgium. [Downloadable!]
  2. Steen Thomsen & Caspar Rose, 2004. "Foundation Ownership and Financial Performance: Do Companies Need Owners?," European Journal of Law and Economics, Springer, vol. 18(3), pages 343-364, December. [Downloadable!] (restricted)
  3. Pedro Garcia-del-Barrio & Stefan Szymanski, 2009. "Goal! Profit Maximization Versus Win Maximization in Soccer," Review of Industrial Organization, Springer, vol. 34(1), pages 45-68, February. [Downloadable!] (restricted)
  4. Burkhard C. Schipper, 2005. "Imitators and Optimizers in Cournot Oligopoly," Discussion Papers 53, SFB/TR 15 Governance and the Efficiency of Economic Systems, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich. [Downloadable!]
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  5. Thomsen, Steen & Rose, Caspar, 2002. "Foundation ownership and financial performance. Do companies need owners?," Working Papers 2002-3, Copenhagen Business School, Department of Finance. [Downloadable!]
  6. Alexander Matros, 2006. "Altruistic Versus Rational Behavior in a Public Good Game," Working Papers 309, University of Pittsburgh, Department of Economics, revised Sep 2008. [Downloadable!]
  7. Luo, Guo Ying, 2009. "Natural Selection, Irrationality and Monopolistic Competition," MPRA Paper 15357, University Library of Munich, Germany. [Downloadable!]
  8. Asplund, Björn Marcus, 2007. "A Test of Profit Maximization," CEPR Discussion Papers 6177, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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