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Asymmetric Information and the New Theory of the Firm: Financial Constraints and Risk Behavior

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  • Bruce C. Greenwald
  • Joseph E. Stiglitz

Abstract

This paper summarizes recent developments in the theory of the firm that have arisen in examining the implications of imperfect information. It shows that a wide range of these models have similar implications for the likely reaction of firms to external environmental and policy changes. Two significant implications are (1) that firms behave as if they are risk averse individuals maximizing a utility function of terminal wealth (profitability) -- even when the risks involved are unsystematic -- and (2), in many circumstances, because this utility function is likely to be characterized by decreasing absolute risk aversion, firms are likely to respond significantly (and positively) to changes in cash flow and profitability. Together these two phenomena are able to account for a wide range of firm behaviors that have been empirically observed (both formally and informally) and that are difficult to explain in terms of the traditional theory of the firm. Furthermore, the responses of such firms to policy interventions are likely to differ significantly from those of neoclassical firms.

Suggested Citation

  • Bruce C. Greenwald & Joseph E. Stiglitz, 1990. "Asymmetric Information and the New Theory of the Firm: Financial Constraints and Risk Behavior," NBER Working Papers 3359, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:3359
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    1. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 84(3), pages 488-500.
    2. Leland, Hayne E & Pyle, David H, 1977. "Informational Asymmetries, Financial Structure, and Financial Intermediation," Journal of Finance, American Finance Association, vol. 32(2), pages 371-387, May.
    3. Bruce C. Greenwald & Joseph E. Stiglitz, 1993. "Financial Market Imperfections and Business Cycles," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 108(1), pages 77-114.
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