Production Theory and the Stock Market
Traditional economic models separate firms' production decisions from equilibrium in stock markets. In this paper, we develop an integrated model of production in the presence of capital asset market equilibrium. Our theory indicates that, in a stochastic environment, production and financial variables are inextricably interrelated. Following the financial equilibrium models of Sharpe, Lintner, and Mossin, we assume that profits and therefore portfolio returns are random. But stockholders can alter their distributions of returns by altering firms' production decisions as well as by altering their portfolios. The key to the analysis is a "unanimity theorem," which shows that in many environments stockholders will agree on optimal output decisions, despite their different expectations and attitudes towards risk. We develop equilibrium conditions which must be satisfied by production decisions. Profit maximization is indeed optimal for a firm whose profits are riskless. But risky firms' outputs depend on financial as well as cost variables, and the equilibrium conditions lead to a theory of production under uncertainty which replaces the now-vacuous notion of profit maximization. We further show that the output decisions will be Pareto optimal for stockholders, and that these decisions maximize market value only in a "purely competitive" world. Our results provide a synthesis of the conflicting conclusions of Diamond, Stiglitz, and Wilson on the optimality of stock markets.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Volume (Year): 5 (1974)
Issue (Month): 1 (Spring)
|Contact details of provider:|| Web page: http://www.rje.org|
|Order Information:||Web: https://editorialexpress.com/cgi-bin/rje_online.cgi|
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Sandmo, Agnar, 1971. "On the Theory of the Competitive Firm under Price Uncertainty," American Economic Review, American Economic Association, vol. 61(1), pages 65-73, March.
- Baron, David P, 1970. "Price Uncertainty, Utility, and Industry Equilibrium in Pure Competition," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 11(3), pages 463-80, October.
- Steinar Ekern & Robert Wilson, 1974. "On the Theory of the Firm in an Economy with Incomplete Markets," Bell Journal of Economics, The RAND Corporation, vol. 5(1), pages 171-180, Spring.
When requesting a correction, please mention this item's handle: RePEc:rje:bellje:v:5:y:1974:i:spring:p:125-144. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.