Normative properties of stock market equilibrium with moral hazard

Michael Magill and Martine Quinzii ()

Journal of Mathematical Economics, 2008, vol. 44, issue 7-8, pages 785-806

Abstract: This paper presents a model of stock market equilibrium with a finite number of corporations and studies its normative properties. Each firm is run by a manager whose effort is unobservable and influences the probabilities of the firm's outcomes. The Board of Directors of each firm chooses an incentive contract for the manager which maximizes the firm's market value. With a finite number of firms, the equilibrium is constrained Pareto optimal only when investors are risk-neutral and firms' outcomes are independent. The inefficiencies which arise when investors are risk-averse, or when firms are influenced by a common shock, are studied and it is shown that under reasonable assumptions there is under investment in effort in equilibrium. The inefficiencies exist when the firms are not completely negligible, as is typical of the large corporations with dispersed ownership traded on public exchanges in the US. In the idealized case where firms of each type are replicated and replaced by a continuum of firms of each type with independent outcomes, the inefficiencies disappear.

Date: 2008

Downloads: (external link)
http://www.sciencedirect.com/science/article/B6VBY ... 2b1c50a30033f8333f05
Full text for ScienceDirect subscribers only

Related works:
Working Paper: Normative Properties of Stock Market Equilibrium with Moral Hazard (2008)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:eee:mateco:v:44:y:2008:i:7-8:p:785-806

Access Statistics for this article

Journal of Mathematical Economics is edited by B. Cornet

More articles in Journal of Mathematical Economics from Elsevier
Series data maintained by Heidi Boesdal ().