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Asymmetric Information and the New Theory of the Firm: Financial Constraints and Risk Behavior

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  • Bruce C. Greenwald
  • Joseph E. Stiglitz

Abstract

This paper summarizes recent developments in the theory of the firm that have arisen in examining the implications of imperfect information. It shows that a wide range of these models have similar implications for the likely reaction of firms to external environmental and policy changes. Two significant implications are (1) that firms behave as if they are risk averse individuals maximizing a utility function of terminal wealth (profitability) -- even when the risks involved are unsystematic -- and (2), in many circumstances, because this utility function is likely to be characterized by decreasing absolute risk aversion, firms are likely to respond significantly (and positively) to changes in cash flow and profitability. Together these two phenomena are able to account for a wide range of firm behaviors that have been empirically observed (both formally and informally) and that are difficult to explain in terms of the traditional theory of the firm. Furthermore, the responses of such firms to policy interventions are likely to differ significantly from those of neoclassical firms.

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File URL: http://www.nber.org/papers/w3359.pdf
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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3359.

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Date of creation: May 1990
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Publication status: published as American Economic Review, Volume 80, Number 2, pp. 160-165 (May 1990)
Handle: RePEc:nbr:nberwo:3359

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  1. Bruce C. Greenwald & Joseph E. Stiglitz, 1988. "Financial Market Imperfections and Business Cycles," NBER Working Papers 2494, National Bureau of Economic Research, Inc.
  2. Leland, Hayne E & Pyle, David H, 1977. "Informational Asymmetries, Financial Structure, and Financial Intermediation," Journal of Finance, American Finance Association, vol. 32(2), pages 371-87, May.
  3. Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, vol. 84(3), pages 488-500, August.
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