Financial Policies and Internal Governance with Heterogeneous Risk Preferences
54 Pages Posted: 6 Apr 2019 Last revised: 30 Oct 2019
Date Written: October 24, 2019
We consider a group of investors with heterogeneous risk preferences that determines a firm's investment policy, and each investor's compensation function. The optimal investment policy is a time-varying weighted average of investors' optimal policies and converges to the policy of the least (most) risk averse investor in booms (busts), reconciling the diversification of opinions hypothesis and the group shift hypothesis. The most (least) risk averse investor receives a strictly concave (convex) claim on the firm's net worth. For intermediate risk preferences investors' claim is S-shaped, resembling preferred stock. We endogenize investors' utility weights absent wealth redistribution, and under social optimization.
Keywords: group decisions, investment, payout, risk preference, governance
JEL Classification: G32, G34, G35
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