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Learning and the Value of the Firm

  • Nobuhiro Kiyotaki
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    The paper studies under what conditions the value of the firm occasionally increases for a while before it suddenly drops, like a "bubble". We consider the environment where the trend of net cash flow from a firm's production depends on uncertain quality of a manager, and the manager is occasionally replaced by a new manager. People know whether the manager is replaced, but they do not know the exact quality of the manager so that they gradually learn about it. We show that, if the current manager is good, the value of the firm tends to increase more rapidly than the net cash flow because people become more and more optimistic about the current manager, until the optimism disappears with sudden retire of the manager. The value of the firms appears to contain a bubble because the value gradually deviates from the present value of the current net cash flow until the deviation disappears. We extend the basic model to allow the firm to replace unsuccessful managers endogenously, and show that the value of the firm more frequently deviates upward from the present value of the current net cash flow than downward.

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    File URL: http://www.nber.org/papers/w3480.pdf
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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3480.

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    Date of creation: Oct 1990
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    Handle: RePEc:nbr:nberwo:3480
    Note: ME
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
    Phone: 617-868-3900
    Web page: http://www.nber.org
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    1. Ariel Pakes & Richard Ericson, 1989. "Empirical Implications of Alternative Models of Firm Dynamics," NBER Working Papers 2893, National Bureau of Economic Research, Inc.
    2. Flood, Robert P & Garber, Peter M, 1980. "Market Fundamentals versus Price-Level Bubbles: The First Tests," Journal of Political Economy, University of Chicago Press, vol. 88(4), pages 745-70, August.
    3. Jovanovic, Boyan, 1982. "Selection and the Evolution of Industry," Econometrica, Econometric Society, vol. 50(3), pages 649-70, May.
    4. Hamilton, James D., 1988. "Rational-expectations econometric analysis of changes in regime : An investigation of the term structure of interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 385-423.
    5. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
    6. Lewis, Karen K, 1989. "Changing Beliefs and Systematic Rational Forecast Errors with Evidence from Foreign Exchange," American Economic Review, American Economic Association, vol. 79(4), pages 621-36, September.
    7. Lewis, Karen K., 1989. "Can learning affect exchange-rate behavior? : The case of the dollar in the early 1980's," Journal of Monetary Economics, Elsevier, vol. 23(1), pages 79-100, January.
    8. Robert P. Flood & Robert J. Hodrick, 1986. "Asset Price Volatility, Bubbles, and Process Switching," NBER Working Papers 1867, National Bureau of Economic Research, Inc.
    9. Flood, Robert P & Garber, Peter M, 1980. "An Economic Theory of Monetary Reform," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 24-58, February.
    10. Tabellini, Guido, 1988. "Learning and the volatility of exchange rates," Journal of International Money and Finance, Elsevier, vol. 7(2), pages 243-250, June.
    11. Hamilton, James D. & Whiteman, Charles H., 1985. "The observable implications of self-fulfilling expectations," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 353-373, November.
    12. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
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