This paper integrates elements from the theory of agency, the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm. We define the concept of agency costs, show its relationship to the ‘separation and control’ issue, investigate the nature of the agency costs generated by the existence of debt and outside equity, demonstrate who bears costs and why, and investigate the Pareto optimality of their existence. We also provide a new definition of the firm, and show how our analysis of the factors influencing the creation and issuance of debt and equity claims is a special case of the supply side of the completeness of markets problem.

If the asset market is incomplete, and if there are two or more consumption goods in each state of nature, then for fixed consumer preferences (of at least two agents), and fixed (non-trivial) technologies for the firm(s), and for a generic assignment of initial endowments, competitive equilibrium investment decisions are constrained inefficient. An outside agency can, simply by redirecting the investment decisions of firms and by lump sum transfers to individuals before the state of nature is realized, make all consumers better off. 1.

Credit constraints that link a private agent’s debt to market-determined prices embody a credit externality that drives a wedge between competitive and constrained socially optimal equilibria, inducing private agents to “overborrow. ” The externality arises because agents fail to internalize the price effects of additional borrowing when the credit constraint binds. We quantify the effects of this inefficiency in a two-sector DSGE model of a small open economy calibrated to emerging markets. The credit externality increases the probability of financial crises by a factor of 7 and causes the maximum drop in consumption to increase by 10 percentage points.

This paper develops an overlapping generations model with stochastic production and incomplete markets to assess whether the introduction of an unfunded social security system can lead to a Pareto improvement, even if the initial equilibrium is neither production-inefficient in the spirit of Diamond (1965) nor dynamically inefficient in the spirit of Samuelson (1957).

It has been suggested that countries whose exports are in especially risky sectors will experience higher output volatility. This paper develops a measure of the riskiness of a country’s pattern of export specialization, and illustrates its features across countries and over time. The exercise reveals large cross-country differences in the risk content of exports. This measure is strongly correlated with the volatility of terms-of-trade, total exports, and output, but does not exhibit a close relationship to the level of income, overall trade openness, or other country characteristics. We then propose an explanation for what determines the risk content of exports, based on the theoretical literature exemplified by Turnovsky (1974). Countries with acomparative advantage in safe sectors or a strong enough comparative advantage in risky sectors will specialize, whereas countries whose comparative advantage in risky sectors is not too strong will diversify their export structure to insure against export income risk. We use both non-parametric and semi-parametric techniques to demonstrate that these theoretical predictions are strongly supported by the data.

In an incomplete market economy, all claim cannot be priced uniquely based on arbitrage. The prices of attainable claims (those that are spanned by traded claims) can be determined uniquely, whereas the prices of those that are unattainable can only be bounded. We first show that tighter price bounds can be determined by considering all possible portfolios of unattainable claims for which there are bid/offer prices. We provide an algorithm to establish these bounds. We then examine how a price-taking agent can “package ” new assets in order to take advantage of the incompleteness since the market places a premium on claims that improve its spanning. In particular, we prove that a firm with a new investment opportunity can maximize its value by “stripping away ” the maximal attainable portion of the cash flow, for which prices are determined uniquely, and selling the balance to investors at prices that preclude arbitrage. Our framework has several applications in financial economics to problems ranging from securitization to the valuation of real options. The authors wish to thank Kose John, Roy Radner and Rangarajan Sundaram for suggestions made during this

efficiency in the neoclassical growth model

Whether public sector projects should be discounted at a lower rate than private sector projects is a highly contentious issue and one that has spawned an enormous literature. The purpose of this paper is to assess the appropriate private and public sector discount rates in the context of public private partnerships. It is shown that there are powerful arguments for using a higher rate to discount private projects than public sector projects and that failure to recognise this may lead to excessive reliance on public provision. It is important to emphasise, however, that the reason for the divergence is not related to the conventional arguments of incomplete markets or taxation. Finally, we suggest that the results may have far broader implications for private sector involvement in public services. JEL Classification: H43

In competitive economies with private firm ownership, incomplete markets, and firm shareholders changing over time, several firm objectives have been proposed. Some are useful to understand efficiency of equilibria, and others are explicitly consistent with majority shareholder control or collective choice rules, but it is not always clear if versions of each type are consistent with versions of the other type. This paper shows that ex-post, value maximizing rules, (including those proposed by Dreze, and Grossman and Hart,) are consistent with shareholder preferences in such economies; that is, along the equilibrium path, in every period and state of the world, every coalition of a firm’s shareholders in that period and state approves a value maximizing production plan. This result applies to cases when shareholders within a firm and across firms can form coalitions, and when stock trading can be ex-dividend or cum-dividend, and with a combination of both. This result does not resolve the problem of inefficiency of stock market equilibria, or that of ex ante disagreement among shareholders. It can help understand when firm objectives with some desirable properties are consistent with a particular version of shareholder control, and it provides a stability criterion (in terms of robustness to shareholder coalitions) for organizing productive

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