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

Author

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  • Hervé Crès

    (GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - HEC Paris - Ecole des Hautes Etudes Commerciales - CNRS - Centre National de la Recherche Scientifique)

  • Mich Tvede

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 holdings 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

  • Hervé Crès & Mich Tvede, 2004. "The Drèze and Grossman-Hart criteria for production in incomplete markets: Voting foundations and compared political stability," Working Papers hal-00591676, HAL.
  • Handle: RePEc:hal:wpaper:hal-00591676
    Note: View the original document on HAL open archive server: https://hal-hec.archives-ouvertes.fr/hal-00591676
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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.
    2. Grossman, Sanford J & Hart, Oliver D, 1979. "A Theory of Competitive Equilibrium in Stock Market Economies," Econometrica, Econometric Society, vol. 47(2), pages 293-329, March.
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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. Geanakoplos, J. & Magill, M. & Quinzii, M. & Dreze, J., 1990. "Generic inefficiency of stock market equilibrium when markets are incomplete," Journal of Mathematical Economics, Elsevier, vol. 19(1-2), pages 113-151.
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    Cited by:

    1. Hervé Crès & Mich Tvede, 2005. "Portfolio Diversification and Internalization of Production Externalities through Majority Voting," Working Papers hal-00587205, HAL.

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    More about this item

    Keywords

    Incomplete markets; super majority voting; sidepayments; corporate charter; self-fulfilling prophecies;
    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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