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Shareholders Unanimity With Incomplete Markets

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  • Daniele Coen-Pirani
  • Eva Carceles-Poveda

Abstract

Macroeconomic models with heterogeneous agents and incomplete markets (e.g. Krusell and Smith, 1998) usually assume that consumers, rather than firms, own and accumulate physical capital. This assumption, while convenient, is without loss of generality only if the asset market is complete. When financial markets are incomplete, shareholders will in general disagree on the optimal level of investment to be undertaken by the firm. This paper derives conditions under which shareholders unanimity obtains in equilibrium despite the incompleteness of the asset market. In the general equilibrium economy analyzed here consumers face idiosyncratic labor income risk and trade firms' shares in the stock market. A firm's shareholders decide how much of its earnings to invest in physical capital and how much to distribute as dividends. The return on a firm's capital investment is affected by an aggregate productivity shock. The paper contains two main results. First, if the production function exhibits constant returns to scale and short-sales constraints are not binding, then in a competitive equilibrium a firm's shareholders will unanimously agree on the optimal level of investment. Thus, the allocation of resources in this economy is the same as in an economy where consumers accumulate physical capital directly. Second, when short-sales constraints are binding, instead, the unanimity result breaks down. In this case, constrained shareholders prefer a higher level of investment than unconstrained ones.

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Paper provided by Carnegie Mellon University, Tepper School of Business in its series GSIA Working Papers with number 2005-E13.

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Handle: RePEc:cmu:gsiawp:1109532697

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Postal: Tepper School of Business, Carnegie Mellon University, 5000 Forbes Avenue, Pittsburgh, PA 15213-3890
Web page: http://www.tepper.cmu.edu/

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Cited by:
  1. Ippei Fujiwara & Yuki Teranishi, 2007. "A Dynamic New Keynesian Life-Cycle Model: Societal Ageing, Demographics and Monetary Policy," IMES Discussion Paper Series 07-E-04, Institute for Monetary and Economic Studies, Bank of Japan.
  2. Alexis Anagnostopoulos & Eva Carceles-Poveda, 2010. "Dividend and Capital Gains Taxation under Incomplete Markets," Department of Economics Working Papers 10-06, Stony Brook University, Department of Economics.
  3. Krusell, Per & Mukoyama, Toshihiko & Sahin, Aysegul, 2009. "Labor-Market Matching with Precautionary Savings and Aggregate Fluctuations," CEPR Discussion Papers 7429, C.E.P.R. Discussion Papers.
  4. Arpad Abraham & Eva Carceles-Poveda, 2006. "Complete Markets, Enforcement Constraints and Intermediation," Computing in Economics and Finance 2006 320, Society for Computational Economics.
  5. Bisin, Alberto; & Gottardi, Piero; & Ruta, Guido, 2014. "Equilibrium corporate finance and intermediation," Economics Working Papers ECO2014/09, European University Institute.
  6. Makoto Nakajima, 2013. "Monetary Policy with Heterogeneous Agents," 2013 Meeting Papers 356, Society for Economic Dynamics.
  7. Arpad Abraham & Eva Carceles-Poveda, 2010. "Competitive Equilibria with Production and Limited Commitment," Department of Economics Working Papers 10-04, Stony Brook University, Department of Economics.
  8. Eva Carceles-Poveda, 2009. "Asset Prices and Business Cycles under Market Incompleteness," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(3), pages 405-422, July.

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