Asset Pricing with a CEO

Abstract

We study an economy with a CEO who trades off the incentive to divert funds, which leads to underinvestment, against the incentive to overinvest based on his optimism. In equilibrium, we see overinvestment relative to what the shareholder or a social planner would implement but underinvestment relative to what the optimistic CEO would implement if there were no feedback between real investment and asset prices. For large wealth shares, the CEO's welfare is higher under a social planner where no funds can be diverted. For small wealth shares, overinvestment peaks and the real short-rate and Tobin's q decline.

Keywords: Optimistic CEO, Tradeoff between Overinvestment and Diversion of Funds, Tobin's q, Welfare

JEL Classification: G11, G12, E21, E22, D51.