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Dividends, Safety and Liquidation when Liabilities are Long-term and Stochastic

  • Mason, Robin

This paper extends the two-period model of Mason and Swanson (1996) to investigate the optimal management of a firm faced with a long-term liability that occurs at a random date. Three issues are analysed: the optimal dividend policy; optimal expenditure on safety to delay the occurrence of any liability; and the optimal liquidation date of the firm. An owner faced with unlimited liability never liquidates and therefore accumulates capital to the golden rule level. For long-term liabilities, dividend payments and safety expenditure are non-decreasing over time. The owner protected by limited liability may liquidate the firm in finite time in order to avoid paying the liability. If this is the case, then it accumulates less capital than the unlimited liability owner, and may decrease dividend payments and safety expenditure over time. The paper shows that a finite liquidation date is more likely to be optimal when the arrival rate of the liability occurrence increases over time.

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Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 9731.

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Date of creation: Aug 1997
Date of revision:
Handle: RePEc:cam:camdae:9731
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  1. Kort, P.M. & Hartl, R.F. & Novak, A.J., 1999. "Optimal investment facing possible accidents," Other publications TiSEM cd61d692-7547-453b-8e91-d, Tilburg University, School of Economics and Management.
  2. Michel, Philippe, 1982. "On the Transversality Condition in Infinite Horizon Optimal Problems," Econometrica, Econometric Society, vol. 50(4), pages 975-85, July.
  3. Ringleb, Al H & Wiggins, Steven N, 1990. "Liability and Large-Scale, Long-term Hazards," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 574-95, June.
  4. Tahvonen, Olli & Withagen, Cees, 1996. "Optimality of irreversible pollution accumulation," Journal of Economic Dynamics and Control, Elsevier, vol. 20(9-10), pages 1775-1795.
  5. Robin Mason & Timothy Swanson, 1996. "Long-term Liability and the Choice of Liquidation*," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan, vol. 21(2), pages 204-223, April.
  6. Clark, Colin W & Clarke, Frank H & Munro, Gordon R, 1979. "The Optimal Exploitation of Renewable Resource Stocks: Problems of Irreversible Investment," Econometrica, Econometric Society, vol. 47(1), pages 25-47, January.
  7. George A. Akerlof & Paul M. Romer, 1993. "Looting: The Economic Underworld of Bankruptcy for Profit," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 24(2), pages 1-74.
  8. Gerald L. Thompson, 1968. "Optimal Maintenance Policy and Sale Date of a Machine," Management Science, INFORMS, vol. 14(9), pages 543-550, May.
  9. Pitchford, Rohan, 1995. "How Liable Should a Lender Be? The Case of Judgment-Proof Firms and Environmental Risk," American Economic Review, American Economic Association, vol. 85(5), pages 1171-86, December.
  10. Fischer, Michael J, 1996. "Union Carbide's Bhopal Incident: A Retrospective," Journal of Risk and Uncertainty, Springer, vol. 12(2-3), pages 257-69, May.
  11. Peter S. Menell, 1991. "The Limitations of Legal Institutions for Addressing Environmental Risks," Journal of Economic Perspectives, American Economic Association, vol. 5(3), pages 93-113, Summer.
  12. Ralph A. Winter, 1991. "The Liability Insurance Market," Journal of Economic Perspectives, American Economic Association, vol. 5(3), pages 115-136, Summer.
  13. Wiggins, Steven N & Ringleb, Al H, 1992. "Adverse Selection and Long-Term Hazards: The Choice between Contract and Mandatory Liability Rules," The Journal of Legal Studies, University of Chicago Press, vol. 21(1), pages 189-215, January.
  14. Clarke, Harry R. & Reed, William J., 1994. "Consumption/pollution tradeoffs in an environment vulnerable to pollution-related catastrophic collapse," Journal of Economic Dynamics and Control, Elsevier, vol. 18(5), pages 991-1010, September.
  15. Bovenberg, A. Lans & Heijdra, Ben J., 1998. "Environmental tax policy and intergenerational distribution," Journal of Public Economics, Elsevier, vol. 67(1), pages 1-24, January.
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