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Agency-Based Asset Pricing

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  • Gary Gorton
  • Ping He

Abstract

We analyze the interaction between managerial decisions and firm value/asset prices by embedding the standard agency model of the firm into an otherwise standard asset pricing model. When the manager-agent's compensation depends on the firm's stock price performance, stock prices are set to induce the creation of future cash flows, instead of representing the discounted value of exogenous cash flows, as in the standard model. In our case, stock prices are formed via trading in the market to induce the managers to hold the number of shares consistent with the optimal effort level desired by the outside investors. We compare two price formation mechanisms, corresponding to two firm ownership structures. In the first, stock prices are formed competitively among a continuum of dispersed investors. In the second, stock prices are set by a single block shareholder, as a bargaining solution. Under both mechanisms there are persistent, dynamic, patterns of asst prices, The level of the equity premium and the return volatility depend on the risk aversion of the agents in the economy and the ownership structure of firms.

Suggested Citation

  • Gary Gorton & Ping He, 2006. "Agency-Based Asset Pricing," NBER Working Papers 12084, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:12084
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    Cited by:

    1. von Lilienfeld-Toal, Ulf & Ruenzi, Stefan, 2006. "Why managers hold shares of their firm: An empirical analysis," CFR Working Papers 06-11, University of Cologne, Centre for Financial Research (CFR).
    2. Gary Gorton & Ping He, 2016. "Optimal Monetary Policy in a Collateralized Economy," NBER Working Papers 22599, National Bureau of Economic Research, Inc.
    3. Bo Sun, 2009. "Asset returns with earnings management," International Finance Discussion Papers 988, Board of Governors of the Federal Reserve System (U.S.).
    4. Asian Development Bank Institute, 2017. "Fossil Fuel Subsidies in Asia: Trends, Impacts, and Reforms - Integrative Report," Working Papers id:11807, eSocialSciences.
    5. Charles S. Tapiero, 2015. "A financial CCAPM and economic inequalities," Quantitative Finance, Taylor & Francis Journals, vol. 15(3), pages 521-534, March.
    6. Allen, Franklin & Vayanos, Dimitri & Vives, Xavier, 2014. "Introduction to financial economics," Journal of Economic Theory, Elsevier, vol. 149(C), pages 1-14.

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    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

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