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The Dreze and Grossman-Hart criteria for production in incomplete markets: Voting foundations and compared political stability

Author

Listed:
  • CRES, Hervé
  • TVEDE, Mich

    (Institute of Economics, University of Copenhagen)

Abstract

This paper studies corporate control in a general equilibrium model with incomplete markets. At the market equilibrium, shareholders typically disagree on the way to evaluate production plans outside the market span. Hence a collective decision mechanism is needed to resolve this conflict. A mechanism proposed by Drèze (1974), resp. Grossman & Hart (1979), consists in allowing (Lindahl-like) sidepayments between final, resp. initial, shareholders. Although it is likely to exhibit desirable efficiency properties, this mechanism is difficult to implement. Another mechanism (e.g., Drèze (1985) and De-Marzo (1993)) relies on majority voting by shareholders. Since voting occurs in a multidimensional setup, super majority rules are needed to ensure existence of equilibria. We give conditions under which sidepayment equilibria are voting equilibria for the smallest rate of super majority ensuring existence. Thereby we are able to compare the relative performances of the Drèze and Grossman-Hart criteria with respect to stability in the voting mechanism. We show that the endogenization of portfolio holding in the Drèze criterion can either help or completely jeopardize the aggregation process, depending on the shareholders' expectations. This ambivalence is absent in the Grossman-Hart criteria.

Suggested Citation

  • CRES, Hervé & TVEDE, Mich, 2004. "The Dreze and Grossman-Hart criteria for production in incomplete markets: Voting foundations and compared political stability," HEC Research Papers Series 794, HEC Paris.
  • Handle: RePEc:ebg:heccah:0794
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    References listed on IDEAS

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    1. Momi, Takeshi, 2001. "Non-existence of equilibrium in an incomplete stock market economy," Journal of Mathematical Economics, Elsevier, vol. 35(1), pages 41-70, February.
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    7. Simon Benninga & Eitan Muller, 1979. "Majority Choice and the Objective Function of the Firm under Uncertainty," Bell Journal of Economics, The RAND Corporation, vol. 10(2), pages 670-682, Autumn.
    8. Louis Gevers, 1974. "Competitive Equilibrium of the Stock Exchange and Pareto Efficiency," International Economic Association Series, in: Jacques H. Drèze (ed.), Allocation under Uncertainty: Equilibrium and Optimality, chapter 10, pages 167-191, Palgrave Macmillan.
    9. Kelsey, David & Milne, Frank, 1996. "The existence of equilibrium in incomplete markets and the objective function of the firm," Journal of Mathematical Economics, Elsevier, vol. 25(2), pages 229-245.
    10. Egbert Dierker & Hildegard Dierker & Birgit Grodal, 2002. "Nonexistence of Constrained Efficient Equilibria When Markets are Incomplete," Econometrica, Econometric Society, vol. 70(3), pages 1245-1251, May.
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    Cited by:

    1. Hervé Crès & Mich Tvede, 2005. "Portfolio Diversification and Internalization of Production Externalities through Majority Voting," SciencePo Working papers hal-01065579, HAL.
    2. repec:spo:wpecon:info:hdl:2441/10281 is not listed on IDEAS
    3. Hervé Crès & Mich Tvede, 2005. "Portfolio Diversification and Internalization of Production Externalities through Majority Voting," Working Papers hal-00587205, HAL.
    4. Hervé Crès & Mich Tvede, 2005. "Portfolio Diversification and Internalization of Production Externalities through Majority Voting," SciencePo Working papers Main hal-01065579, HAL.
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    More about this item

    Keywords

    incomplete markets; super majority voting; sidepayments; corporate charter; self-fulfilling prophcies;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D71 - Microeconomics - - Analysis of Collective Decision-Making - - - Social Choice; Clubs; Committees; Associations
    • G39 - Financial Economics - - Corporate Finance and Governance - - - Other

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