Imperfect Financial Markets and Shareholder Incentives in Partial and General Equilibrium

58 Pages Posted: 24 May 2017

See all articles by Elias Albagli

Elias Albagli

University of Southern California - Marshall School of Business; Central Bank of Chile

Christian Hellwig

University of Toulouse 1 - Toulouse School of Economics (TSE)

Aleh Tsyvinski

Yale University - Cowles Foundation

Multiple version iconThere are 2 versions of this paper

Date Written: May 2017

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.

Suggested Citation

Albagli, Elias and Hellwig, Christian and Tsyvinski, Aleh, Imperfect Financial Markets and Shareholder Incentives in Partial and General Equilibrium (May 2017). NBER Working Paper No. w23419. Available at SSRN: https://ssrn.com/abstract=2971816

Elias Albagli (Contact Author)

University of Southern California - Marshall School of Business ( email )

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HOME PAGE: http://www.marshall.usc.edu/faculty/directory/albagli

Central Bank of Chile ( email )

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Chile

Christian Hellwig

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

Aleh Tsyvinski

Yale University - Cowles Foundation ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States
203-432-9163 (Phone)

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