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Equilibrium Investment and Asset Prices under Imperfect Corporate Control

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  • James Dow
  • Gary Gorton
  • Arvind Krishnamurthy

Abstract

We integrate a widely accepted version of the separation of ownership and control—Michael Jensen's (1986) free cash flow theory—into a dynamic equilibrium model, and study the effect of imperfect corporate control on asset prices and investment. Aggregate free cash flow of the corporate sector is an important state variable in explaining asset prices, investment, and the cyclical behavior of interest rates and the yield curve. The financial friction causes cash-flow shocks to affect investment, and causes otherwise i.i.d. shocks to be transmitted from period to period. The shocks propagate through large firms and during booms.

Suggested Citation

  • James Dow & Gary Gorton & Arvind Krishnamurthy, 2005. "Equilibrium Investment and Asset Prices under Imperfect Corporate Control," American Economic Review, American Economic Association, vol. 95(3), pages 659-681, June.
  • Handle: RePEc:aea:aecrev:v:95:y:2005:i:3:p:659-681 Note: DOI: 10.1257/0002828054201422
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    References listed on IDEAS

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    Cited by:

    1. repec:bla:randje:v:48:y:2017:i:1:p:147-177 is not listed on IDEAS
    2. Bisin, Alberto; & Gottardi, Piero; & Ruta, Guido, 2014. "Equilibrium corporate finance and intermediation," Economics Working Papers ECO2014/09, European University Institute.
    3. Dow, James & Han, Jungsuk, 2015. "Contractual incompleteness, limited liability and asset price bubbles," Journal of Financial Economics, Elsevier, vol. 116(2), pages 383-409.
    4. Mukherjee, Rahul, 2015. "Institutions, Corporate Governance and Capital Flows," Journal of International Economics, Elsevier, pages 338-359.
    5. Jean-Pierre Danthine & John Donaldson, 2015. "Executive Compensation: A General Equilibrium Perspective," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(2), pages 269-286, April.
    6. Rui Albuquerue & Neng Wang, 2008. "Agency Conflicts, Investment, and Asset Pricing," Journal of Finance, American Finance Association, vol. 63(1), pages 1-40, February.
    7. Henderson, Vicky, 2010. "Is corporate control effective when managers face investment timing decisions in incomplete markets?," Journal of Economic Dynamics and Control, Elsevier, vol. 34(6), pages 1062-1076, June.
    8. Dalida Kadyrzhanova, 2005. "Predatory Governance," Computing in Economics and Finance 2005 421, Society for Computational Economics.
    9. King, Tao-Hsien Dolly & Wen, Min-Ming, 2011. "Shareholder governance, bondholder governance, and managerial risk-taking," Journal of Banking & Finance, Elsevier, vol. 35(3), pages 512-531, March.
    10. Enrique Schroth & Rui Albuquerque, 2008. "Determinants Of The Block Premium And Of Private Benefits Of Control," 2008 Meeting Papers 655, Society for Economic Dynamics.
    11. Gorton, Gary B. & He, Ping & Huang, Lixin, 2014. "Agency-based asset pricing," Journal of Economic Theory, Elsevier, vol. 149(C), pages 311-349.
    12. Jean Tirole, 2013. "Comment on "Pledgability and Liquidity: A New Monetarist Model of Financial and Macroeconomic Activity"," NBER Chapters,in: NBER Macroeconomics Annual 2013, Volume 28, pages 279-286 National Bureau of Economic Research, Inc.
    13. Chang-Koo Chi & Kyoung Jin Choi, 2017. "The impact of firm size on dynamic incentives and investment," RAND Journal of Economics, RAND Corporation, vol. 48(1), pages 147-177, March.

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