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Shareholders Unanimity With Incomplete Markets

Author

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  • Daniele Coen-Pirani

Abstract

When financial markets are incomplete, shareholders will in general disagree on the optimal level of investment to be undertaken by the firm (Grossman and Hart, 1979). Macroeconomic models with heterogeneous agents and incomplete markets (e.g. Krusell and Smith, 1998) usually ignore this issue by assuming that consumers, rather than firms, make the decision to accumulate capital. This assumption, while convenient, is in general without loss of generality only if the asset market is complete. This paper derives conditions under which shareholders unanimity obtains in equilibrium despite the incompleteness of the asset market. In the model economy analyzed here consumers face idiosyncratic labor income risk and the only asset they have access to is the stock of the representative firm. The firm (i.e. its shareholders) decides how much of its earnings to invest in physical capital and how much to distribute as dividends. The rate of return on capital is random. The main result of the paper is that, if the firm's production function exhibits constant returns to scale, then in a competitive equilibrium shareholders will unanimously agree on the optimal level of investment. As a result, in this incomplete markets economy the equilibrium stock price of the firm is always equal to its capital stock, just as in a complete markets setting. However, the equilibrium level of the capital stock differs from what is obtained under complete markets.

Suggested Citation

  • Daniele Coen-Pirani, 2004. "Shareholders Unanimity With Incomplete Markets," 2004 Meeting Papers 479, Society for Economic Dynamics.
  • Handle: RePEc:red:sed004:479
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    Cited by:

    1. Bisin, Alberto; & Gottardi, Piero; & Ruta, Guido, 2014. "Equilibrium corporate finance and intermediation," Economics Working Papers ECO2014/09, European University Institute.
    2. Anagnostopoulos, Alexis & Cárceles-Poveda, Eva & Lin, Danmo, 2012. "Dividend and capital gains taxation under incomplete markets," Journal of Monetary Economics, Elsevier, vol. 59(7), pages 599-611.
    3. Per Krusell & Toshihiko Mukoyama & Ayşegül Şahin, 2010. "Labour-Market Matching with Precautionary Savings and Aggregate Fluctuations," Review of Economic Studies, Oxford University Press, vol. 77(4), pages 1477-1507.
    4. Eva Carceles-Poveda & Arpad Abraham, 2005. "Complete Markets, Enforcement Constraints and Intermediation," 2005 Meeting Papers 661, Society for Economic Dynamics.
    5. Eva Carceles-Poveda, 2009. "Asset Prices and Business Cycles under Market Incompleteness," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(3), pages 405-422, July.
    6. Arpad Abraham & Eva Carceles-Poveda, 2010. "Competitive Equilibria with Production and Limited Commitment," Department of Economics Working Papers 10-04, Stony Brook University, Department of Economics.
    7. Nils Gornemann & Keith Kuester & Makoto Nakajima, 2012. "Monetary policy with heterogeneous agents," Working Papers 12-21, Federal Reserve Bank of Philadelphia.
    8. Fujiwara, Ippei & Teranishi, Yuki, 2008. "A dynamic new Keynesian life-cycle model: Societal aging, demographics, and monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 32(8), pages 2398-2427, August.
    9. Alexis Anagnostopoulos & Orhan Erem Atesagaoglu & Eva Carceles-Poveda, 2014. "On the Double Taxation of Corporate Profits," Department of Economics Working Papers 14-03, Stony Brook University, Department of Economics.

    More about this item

    Keywords

    incomplete markets; investment; firm; shareholders;

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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