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Equity Financing

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  • Eva Carceles-Poveda

    (SUNY Stony Brook and IAE)

  • Albert Marcet

    (IAE)

  • Alexis Anagnostopoulos

    (SUNY Stony Brook)

Abstract

This paper studies a model of corporate finance in which firms use stock issuance to finance investment. In contrast to the existing literature, we assume that the firm is "rational" and therefore recognizes the relationship between future dividends and stock prices. Under this assumption, future variables enter in the constraints of the firm, so that the problem is not recursive in a standard sense and the Bellman equation does not hold. This implies that the model has to be solved with recursive contracts methods such as the ones used, for example, in models of optimal macroeconomic policy or in risk sharing models with participation constraints. In addition, financial policy may be time inconsistent. First, we characterize several cases where time consistency arises. Second, we compare numerically the full commitment (and potentially time inconsistent) solution of a "rational" firm to the one of a "naive" firm that ignores the relationship between current price and future dividends. First, our results suggest that growing firms will pay lower dividends at the beginning and promise higher dividends in the future. This allows them to raise cheaper external funds through a higher value of stocks, accumulate more capital, and grow faster.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 954.

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Date of creation: 2008
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Handle: RePEc:red:sed008:954

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  1. Francisco Covas & Wouter Denhaan, 2006. "The role of debt and equity finance over the business cycle," 2006 Meeting Papers 407, Society for Economic Dynamics.
  2. Albert Marcet & Thomas J. Sargent & Juha Seppala, 1996. "Optimal taxation without state-contingent debt," Economics Working Papers 170, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2001.
  3. Miller, Merton H & Rock, Kevin, 1985. " Dividend Policy under Asymmetric Information," Journal of Finance, American Finance Association, vol. 40(4), pages 1031-51, September.
  4. Sudipto Bhattacharya, 1979. "Imperfect Information, Dividend Policy, and "The Bird in the Hand" Fallacy," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 259-270, Spring.
  5. Hopenhayn, Hugo A, 1992. "Entry, Exit, and Firm Dynamics in Long Run Equilibrium," Econometrica, Econometric Society, vol. 60(5), pages 1127-50, September.
  6. Vincenzo Quadrini & Urban Jermann, 2005. "Financial Development and Macroeconomic Stability," 2005 Meeting Papers 692, Society for Economic Dynamics.
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Cited by:
  1. Albert Marcet & Ramon Marimon, 1994. "Recursive contracts," Economics Working Papers 337, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 1998.

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