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Equity Financing

  • Eva Carceles-Poveda

    (SUNY Stony Brook and IAE)

  • Albert Marcet

    (IAE)

  • Alexis Anagnostopoulos

    (SUNY Stony Brook)

This paper studies a model of corporate finance in which firms use stock issuance to finance investment. In contrast to the existing literature, we assume that the firm is "rational" and therefore recognizes the relationship between future dividends and stock prices. Under this assumption, future variables enter in the constraints of the firm, so that the problem is not recursive in a standard sense and the Bellman equation does not hold. This implies that the model has to be solved with recursive contracts methods such as the ones used, for example, in models of optimal macroeconomic policy or in risk sharing models with participation constraints. In addition, financial policy may be time inconsistent. First, we characterize several cases where time consistency arises. Second, we compare numerically the full commitment (and potentially time inconsistent) solution of a "rational" firm to the one of a "naive" firm that ignores the relationship between current price and future dividends. First, our results suggest that growing firms will pay lower dividends at the beginning and promise higher dividends in the future. This allows them to raise cheaper external funds through a higher value of stocks, accumulate more capital, and grow faster.

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File URL: https://economicdynamics.org/meetpapers/2008/paper_954.pdf
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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 954.

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Date of creation: 2008
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Handle: RePEc:red:sed008:954
Contact details of provider: Postal:
Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/society.htm
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