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A Unified Model of Firm Dynamics with Limited Commitment and Assortative Matching

Hengjie Ai, Dana Kiku, Rui Li and Jincheng Tong

Journal of Finance, 2021, vol. 76, issue 1, 317-356

Abstract: We develop a unified theory of dynamic contracting and assortative matching to explain firm dynamics. In our model, neither firms nor managers can commit to arrangements that yield lower payoffs than their outside options, which are microfounded by the equilibrium conditions in a matching market. The model endogenously generates power laws in firm size and CEO compensation, and explains differences in their right tails. We also show that our model quantitatively accounts for many salient features of the time‐series dynamics and the cross‐sectional distribution of firm investment, dividend payout, and CEO compensation.

Date: 2021
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https://doi.org/10.1111/jofi.12980

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