Investment and financing in incomplete markets

Abstract

I propose a model of production with incomplete financial markets, in which a firm can act as a financial innovator by issuing claims against its stock. In this environment, market value maximization may be against the firm’s shareholders’ interests. I propose instead a new measure of adjusted value, which is the sum between the market value and the shareholders’ surplus from their trades in the stock market. If a firm maximizes its adjusted value, then its financial policy is relevant (that is, Modigliani–Miller theorem does not hold), equilibrium outcomes are stable to shareholders’ renegotiation, and endogenously incomplete markets can arise at the equilibrium. If the firm is competitive, the adjusted value coincides with the objective proposed by Grossman and Hart (Econometrica 47(2):293–329, 1979). In a competitive market with no production-specific uninsurable risk (that is, spanning property holds), the adjusted value coincides with the market value.