Risk-taking, Rent-seeking and Investment when Financial Markets are Noisy

Christian Hellwig, Aleh Tsyvinski and Elias Albagli
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Elias Albagli: Central Bank of Chile

No 1170, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: Abstract We analyze investment and risk-taking by firms and identify a new distortion due to market imperfections and shareholder incentives. First we show that noisy information aggregation introduces a rent-shifting motive and leads to inefficient investment. These inefficiencies are particularly severe if upside risks are coupled with near constant returns to scale. We consider four applications of our model that give rise to excess leverage, negative welfare effects of transparency, excess sensitivity of investment to stock prices, and dynamically inconsistent firm behavior. Our third contribution is to evaluate various welfare improving policy interventions.

Date: 2017
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