Learning and the Value of the Firm
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.
|Date of creation:||Oct 1990|
|Date of revision:|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
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- 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.
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NBER Working Papers
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NBER Working Papers
1867, National Bureau of Economic Research, Inc.
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UCLA Economics Working Papers
434, UCLA Department of Economics.
- 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.
- Jovanovic, Boyan, 1982. "Selection and the Evolution of Industry," Econometrica, Econometric Society, vol. 50(3), pages 649-70, May.
- 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.
- 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.
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