Imperfect Financial Markets and Shareholder Incentives in Partial and General Equilibrium

Elias Albagli, Christian Hellwig and Aleh Tsyvinski

No 23419, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We analyze the firm-level and aggregate consequences of equity market imperfections in the form of noisy information aggregation for corporate risk-taking and investment. Market imperfections cause controlling shareholders to invest too much in upside risks and too little in downside risks in an attempt to capture market rents. In partial equilibrium, these inefficiencies are particularly severe if upside risks are coupled with near constant returns to scale. In general equilibrium, the shareholders’ collective attempts to boost shareholder value of individual firms leads to a novel pecuniary externality that amplifies investment distortions with downside risks but offsets distortions with upside risks, thereby overturning the results from the partial equilibrium analysis. We consider policy interventions to correct the distortions, and show that in general equilibrium such interventions disrupt the financial market’s allocational role. We analyze extensions of our model to excess leverage, agency conflicts between shareholders and managers, negative welfare effects of transparency, excess sensitivity of investment to stock prices, and dynamically inconsistent firm behavior.

JEL-codes: D21 E22 G1 G18 (search for similar items in EconPapers)
Date: 2017-05
Note: CF EFG
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Citations: View citations in EconPapers (5)

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