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American Economic Review Vol. 95 No. 3 2005

Equilibrium Investment and Asset Prices under Imperfect Corporate Control

James Dow1; Gary Gorton2; Arvind Krishnamurthy3

1 Department of Finance, London Business School, London NW1 4SA, United Kingdom. · 2 Department of Finance, The Wharton School, University of Pennsylvania, Philadelphia, PA 19104 and National Bureau of Economic Research. · 3 Department of Finance, Kellogg School of Management, Northwestern University, Evanston, IL 60208.

Abstract

We integrate a widely accepted version of the separation of ownership and control—Michael Jensen's (1986) free cash flow theory—into a dynamic equilibrium model, and study the effect of imperfect corporate control on asset prices and investment. Aggregate free cash flow of the corporate sector is an important state variable in explaining asset prices, investment, and the cyclical behavior of interest rates and the yield curve. The financial friction causes cash-flow shocks to affect investment, and causes otherwise i.i.d. shocks to be transmitted from period to period. The shocks propagate through large firms and during booms.

DOI
10.1257/0002828054201422
Volume
95
Issue
3
Pages
659-681
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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