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Profit Maximization and the Market Selection Hypothesis

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  • Dutta, Prajit K
  • Radner, Roy
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    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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    Bibliographic Info

    Article provided by Wiley Blackwell 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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    Cited by:
    1. Luo, Guo Ying, 2009. "Natural Selection, Irrationality and Monopolistic Competition," MPRA Paper 15357, University Library of Munich, Germany.
    2. Schipper, Burkhard C., 2005. "Imitators and Optimizers in Cournot Oligopoly," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 53, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    3. Alexander Matros, 2006. "Altruistic Versus Rational Behavior in a Public Good Game," Working Papers 309, University of Pittsburgh, Department of Economics, revised Sep 2008.
    4. Edoardo Gaffeo & Domenico Delli Gatti & Saul Desiderio & Mauro Gallegati, 2008. "Adaptive microfoundations for emergent macroeconomics," Department of Economics Working Papers 0802, Department of Economics, University of Trento, Italia.
    5. 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.
    6. Larsson, Bo & Wijkander, Hans, 2012. "Banking on Regulations?," Research Papers in Economics 2012:3, Stockholm University, Department of Economics.
    7. Thomsen, Steen & Rose, Caspar, 2002. "Foundation ownership and financial performance. Do companies need owners?," Working Papers 2002-3, Copenhagen Business School, Department of Finance.
    8. Lawrence E. Blume & David Easley, 1998. "Optimality and Natural Selection in Markets," Working Papers 98-09-082, Santa Fe Institute.
    9. Asplund, Björn Marcus, 2007. "A Test of Profit Maximization," CEPR Discussion Papers 6177, C.E.P.R. Discussion Papers.
    10. Cho, In-Koo & Kasa, Kenneth, 2014. "An escape time interpretation of robust control," Journal of Economic Dynamics and Control, Elsevier, vol. 42(C), pages 1-12.
    11. Ingham, Alan & Ma, Jie & Ulph, Alistair, 2007. "Climate change, mitigation and adaptation with uncertainty and learning," Energy Policy, Elsevier, vol. 35(11), pages 5354-5369, November.
    12. William Collier & Francis Green & Young-Bae Kim & John Peirson, 2008. "Education, Training and Economic Performance: Evidence from Establishment Survival Data," Studies in Economics 0822, Department of Economics, University of Kent.
    13. 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.

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