Abstract
When markets are incomplete, shareholders typically disagree on the firm's optimal investment plan. This article studies the shareholders' preferences with respect to the firm's investment in a model with aggregate risk, incomplete markets and heterogeneous households who trade in firms' shares instead of directly accumulating physical capital. If the production function exhibits constant returns to scale and borrowing limits are not binding, a firm's shareholders unanimously agree on its optimal level of investment. In contrast, with binding borrowing constraints, constrained shareholders prefer a higher level of investment than unconstrained ones.
Highlights
During recent years, macroeconomists have explored the implications of dynamic general equilibrium models with heterogeneous agents, incomplete markets and aggregate risk for a variety of issues, including asset pricing, business cycles, and the distribution of income and wealth
Using a two-period version of the standard incomplete markets in macroeconomics, we show that, if the production function exhibits constant returns to scale in capital and labor and borrowing constraints are not binding, a ...rm’s shareholders will unanimously agree on the optimal level of investment in a production equilibrium
We show that our unanimity result is even stronger in a multiperiod economy, since there is no disagreement among shareholders at di¤erent dates
Summary
Macroeconomists have explored the implications of dynamic general equilibrium models with heterogeneous agents, incomplete markets and aggregate risk for a variety of issues, including asset pricing (see e.g. Krusell and Smith, 1997 and Storesletten, Telmer, and Yaron, 2007), business cycles (see e.g. Krusell and Smith, 1998), and the distribution of income and wealth (see e.g. Castaneda, DiazGimenez and Rios-Rull, 1998). Using a two-period version of the standard incomplete markets in macroeconomics, we show that, if the production function exhibits constant returns to scale in capital and labor and borrowing constraints are not binding, a ...rm’s shareholders will unanimously agree on the optimal level of investment in a production equilibrium. The assumptions of constant returns to scale and no binding borrowing limits imply that shareholders are unanimous in choosing a level of capital that maximizes the ...rm’s stock market value. This implies that the allocation of resources in the economy we consider is the same as in the standard setting where ...rms maximize period-by-period pro...ts.
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