The Dynamics of Financial Policies and Group Decisions in Private Firms
57 Pages Posted: 6 Apr 2019 Last revised: 12 Apr 2021
Date Written: March 27, 2020
We model a private firm founded and run by a group of investors with heterogeneous capital contributions and risk preferences who decide on the firm's financial policies and governance. Investors' optimal claims resemble preferred stock with heterogeneous dividend caps, and common stock. Cashflow rights and control rights are separated and time-varying. 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 (recessions). Optimal leverage is procyclical. The dynamic financial policies and diversity in equity claims resolve investors' diverging preferences and inability to trade.
Keywords: group decisions, investment, payout, risk preference, governance
JEL Classification: G32, G34, G35
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