Asymmetric Information and the New Theory of the Firm: Financial Constraints and Risk Behavior

15 Pages Posted: 27 Apr 2000 Last revised: 8 Sep 2010

See all articles by Bruce C. N. Greenwald

Bruce C. N. Greenwald

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Joseph E. Stiglitz

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Date Written: May 1990

Abstract

This paper summarizes recent developments in the theory of the firm that have arisen in examining the implications of imperfect information. It shows that a wide range of these models have similar implications for the likely reaction of firms to external environmental and policy changes. Two significant implications are (1) that firms behave as if they are risk averse individuals maximizing a utility function of terminal wealth (profitability) -- even when the risks involved are unsystematic -- and (2), in many circumstances, because this utility function is likely to be characterized by decreasing absolute risk aversion, firms are likely to respond significantly (and positively) to changes in cash flow and profitability. Together these two phenomena are able to account for a wide range of firm behaviors that have been empirically observed (both formally and informally) and that are difficult to explain in terms of the traditional theory of the firm. Furthermore, the responses of such firms to policy interventions are likely to differ significantly from those of neoclassical firms.

Suggested Citation

Greenwald, Bruce and Stiglitz, Joseph E., Asymmetric Information and the New Theory of the Firm: Financial Constraints and Risk Behavior (May 1990). NBER Working Paper No. w3359. Available at SSRN: https://ssrn.com/abstract=226660

Bruce Greenwald (Contact Author)

Columbia Business School - Finance and Economics ( email )

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Joseph E. Stiglitz

Columbia Business School - Finance and Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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