Template-Type: ReDIF-Paper 1.0
Author-Name: Martine Quinzii
Author-Name-First: Martine
Author-Name-Last: Quinzii
Author-Name: Michael Magill
Author-Name-First: Michael
Author-Name-Last: Magill
Author-Workplace-Name: Department of Economics, University of California Davis
Title: NORMATIVE PROPERTIES OF STOCK MARKET  EQUILIBRIUM WITH MORAL HAZARD
Abstract: This paper presents a model of stock market equilibrium with a finite number of corporations
 and studies its normative properties. Each firm is run by a manager whose effort is unobservable
 and influences the probabilities of the firm?s outcomes. The Board of Directors of each firm chooses
 an incentive contract for the manager which maximizes the firm?s market value. With a finite
 number of firms, the equilibrium is constrained Pareto optimal only when investors are risk neutral
 and firms? outcomes are independent. The inefficiencies which arise when investors are risk averse,
 or when firms are influenced by a common shock, are studied and it is shown that under reasonable
 assumptions there is under investment in effort in equilibrium. The inefficiencies exist when the
 firms are not completely negligible, as is typical of the large corporations with dispersed ownership
 traded on public exchanges in the US. In the idealized case where firms of each type are replicated
 and replaced by a continuum of firms of each type with independent outcomes, the inefficiencies
 disappear.
Length: 36
File-URL: https://repec.dss.ucdavis.edu/files/fsLXgS1o5eQojB4uYrPgzTRz/08-2.pdf
File-Format: application/pdf
Number: 79
Classification-JEL: G0, G1
KeyWords: market, economics, stock
Creation-Date: 18991231
Handle: RePEc:cda:wpaper:79