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Shareholders Unanimity With Incomplete Markets

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  • Daniele Coen-Pirani

Abstract

When financial markets are incomplete, shareholders will in general disagree on the optimal level of investment to be undertaken by the firm (Grossman and Hart, 1979). Macroeconomic models with heterogeneous agents and incomplete markets (e.g. Krusell and Smith, 1998) usually ignore this issue by assuming that consumers, rather than firms, make the decision to accumulate capital. This assumption, while convenient, is in general without loss of generality only if the asset market is complete. This paper derives conditions under which shareholders unanimity obtains in equilibrium despite the incompleteness of the asset market. In the model economy analyzed here consumers face idiosyncratic labor income risk and the only asset they have access to is the stock of the representative firm. The firm (i.e. its shareholders) decides how much of its earnings to invest in physical capital and how much to distribute as dividends. The rate of return on capital is random. The main result of the paper is that, if the firm's production function exhibits constant returns to scale, then in a competitive equilibrium shareholders will unanimously agree on the optimal level of investment. As a result, in this incomplete markets economy the equilibrium stock price of the firm is always equal to its capital stock, just as in a complete markets setting. However, the equilibrium level of the capital stock differs from what is obtained under complete markets.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 479.

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Date of creation: 2004
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Handle: RePEc:red:sed004:479

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Keywords: incomplete markets; investment; firm; shareholders;

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Cited by:
  1. Makoto Nakajima, 2013. "Monetary Policy with Heterogeneous Agents," 2013 Meeting Papers, Society for Economic Dynamics 356, Society for Economic Dynamics.
  2. Krusell, Per & Mukoyama, Toshihiko & Sahin, Aysegul, 2009. "Labor-Market Matching with Precautionary Savings and Aggregate Fluctuations," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7429, C.E.P.R. Discussion Papers.
  3. Anagnostopoulos, Alexis & Cárceles-Poveda, Eva & Lin, Danmo, 2012. "Dividend and capital gains taxation under incomplete markets," Journal of Monetary Economics, Elsevier, Elsevier, vol. 59(7), pages 599-611.
  4. Alberto Bisin & Piero Gottardi & Guido Ruta, 2014. "Equilibrium Corporate Finance and Intermediation," NBER Working Papers 20345, National Bureau of Economic Research, Inc.
  5. Fujiwara, Ippei & Teranishi, Yuki, 2008. "A dynamic new Keynesian life-cycle model: Societal aging, demographics, and monetary policy," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 32(8), pages 2398-2427, August.
  6. Arpad Abraham & Eva Carceles-Poveda, 2010. "Competitive Equilibria with Production and Limited Commitment," Department of Economics Working Papers, Stony Brook University, Department of Economics 10-04, Stony Brook University, Department of Economics.
  7. Arpad Abraham & Eva Carceles-Poveda, 2006. "Complete Markets, Enforcement Constraints and Intermediation," Computing in Economics and Finance 2006, Society for Computational Economics 320, Society for Computational 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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