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Equilibrium Investment and Asset Prices under Imperfect Corporate Control

  • James Dow
  • Gary Gorton
  • Arvind Krishnamurthy

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.

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/0002828054201422
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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 95 (2005)
Issue (Month): 3 (June)
Pages: 659-681

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Handle: RePEc:aea:aecrev:v:95:y:2005:i:3:p:659-681
Note: DOI: 10.1257/0002828054201422
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  1. Olivier J. Blanchard & Florencio Lopez-de-Silane, 1993. "What do Firms do with Cash Windfalls?," NBER Working Papers 4258, National Bureau of Economic Research, Inc.
  2. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
  3. Abel, Andrew B & Eberly, Janice C, 1996. "Optimal Investment with Costly Reversibility," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 581-93, October.
  4. Jonathan Berk & Richard C. Green & Vasant Naik, 1998. "Optimal Investment, Growth Options, and Security Returns," NBER Working Papers 6627, National Bureau of Economic Research, Inc.
  5. Michele Boldrin & Lawrence J. Christiano & Jonas D. M. Fisher, 2000. "Habit persistence, asset returns and the business cycle," Staff Report 280, Federal Reserve Bank of Minneapolis.
  6. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
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