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Firms, Shareholders, and Financial Markets

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  • Leonard J. Mirman
  • Marc Santugini

    ()
    (IEA, HEC Montréal)

Abstract

We study the influence of the financial market on the decisions of firms in the real market. To that end, we present a model in which the shareholders’ portfolio selection of assets and the decisions of the publicly-traded firms are integrated through the market process. Financial access alters the objective function of the firms, and the market interaction of shareholders substantially influences firms’ behavior in the real sector. After characterizing the unique equilibrium, we show that the financial sector integrates the preferences of all shareholders into the decisions for production and ownership structure. The participation from investors in the financial market also limits the firms’ ability to manipulate real prices, i.e., there is a loss of market power in the real sector. Note that, while the loss of market power changes expected profits, it is not detrimental to shareholders since the expected return of equity share depends on the variance (and not the mean) of profits. Indeed, any change in expected profits is absorbed by the financial price. We also show that financial access increases production, thereby altering the distribution of profits. In particular, financial access induces firms to take on more risk. Finally, financial access makes the relationship between risk-aversion and risk-taking ambiguous. For example, it is possible that an increase in risk-aversion leads to more risk-taking, i.e., the variance of real profits increases.

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Bibliographic Info

Paper provided by HEC Montréal, Institut d'économie appliquée in its series Cahiers de recherche with number 08-05.

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Length: 41 pages
Date of creation: Jul 2008
Date of revision: Mar 2013
Handle: RePEc:iea:carech:0805

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Postal: Institut d'économie appliquée HEC Montréal 3000, Chemin de la Côte-Sainte-Catherine Montréal, Québec H3T 2A7
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Related research

Keywords: Financial sector; Firm behavior; Market power; Monopoly; Perfect competition; Publicly-traded firm; Shareholder behavior.;

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References

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  1. Luis Angel Medrano & Xavier Vives, 2004. "Regulating Insider Trading When Investment Matters," Review of Finance, Springer, Springer, vol. 8(2), pages 199-277.
  2. Sanford Grossman & Oliver Hart, . "An Analysis of the Principal-Agent Problem," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 15-80, Wharton School Rodney L. White Center for Financial Research.
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  10. Admati, Anat R & Pfleiderer, Paul & Zechner, Josef, 1994. "Large Shareholder Activism, Risk Sharing, and Financial Market Equilibrium," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 102(6), pages 1097-1130, December.
  11. Leonard J. Mirman & Neelam Jain, 2000. "Real and financial effects of insider trading with correlated signals," Economic Theory, Springer, Springer, vol. 16(2), pages 333-353.
  12. Peter M. DeMarzo & Branko Uro, 2006. "Ownership Dynamics and Asset Pricing with a Large Shareholder," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 114(4), pages 774-815, August.
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  14. Arrow, Kenneth J & Lind, Robert C, 1970. "Uncertainty and the Evaluation of Public Investment Decisions," American Economic Review, American Economic Association, American Economic Association, vol. 60(3), pages 364-78, June.
  15. Showalter, Dean M, 1995. "Oligopoly and Financial Structure: Comment," American Economic Review, American Economic Association, American Economic Association, vol. 85(3), pages 647-53, June.
  16. Mirrlees, J A, 1999. "The Theory of Moral Hazard and Unobservable Behaviour: Part I," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 66(1), pages 3-21, January.
  17. Jain, Neelam & Mirman, Leonard J., 1999. "Insider trading with correlated signals," Economics Letters, Elsevier, Elsevier, vol. 65(1), pages 105-113, October.
  18. Ross, Stephen A, 1973. "The Economic Theory of Agency: The Principal's Problem," American Economic Review, American Economic Association, American Economic Association, vol. 63(2), pages 134-39, May.
  19. Dotan, Amihud & Ravid, S Abraham, 1985. " On the Interaction of Real and Financial Decisions of the Firm under Uncertainty," Journal of Finance, American Finance Association, American Finance Association, vol. 40(2), pages 501-17, June.
  20. Baron, David P, 1971. "Demand Uncertainty in Imperfect Competition," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 12(2), pages 196-208, June.
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Citations

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Cited by:
  1. Eric Fesselmeyer & Leonard J. Mirman & Marc Santugini, 2012. "A Reconsideration of Arrow-Lind: Risk Aversion, Risk Sharing, and Agent Choice," Cahiers de recherche, CIRPEE 1201, CIRPEE.
  2. Leonard J. Mirman & Egas M. Salgueiro & Marc Santugini, 2013. "Issues on Integrating Real and Financial Decisions," Cahiers de recherche, CIRPEE 1333, CIRPEE.
  3. Eric Fesselmeyer & Leonard J. Mirman & Marc Santugini, 2012. "Risk Sharing in an Asymmetric Environment," Cahiers de recherche, CIRPEE 1236, CIRPEE.

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