Abstract not found

What are the long-run effects of dividend taxation on aggregate capital accumulation and welfare? To address this question, we build a dynamic general equilibrium model in which there is a continuum of firms subject to idiosyncratic productivity shocks. We show that at any point in time, a firm may lie in one of three finance regimes: dividend distribution regime, liquidity constrained regime, and equity issuance regime. These finance regimes may change over time in response to idiosyncratic productivity shocks. Firms in different finance regimes respond to dividend taxation in different ways. We calibrate our model to the US data from COMPUSTAT and use this calibrated model to provide an initial quantitative evaluation of the Bush government dividend tax reform in 2003. Our baseline model simulations show that when both dividend and capital gains tax rates are cut from 25 and 20 percent, respectively, to the same 15 percent level permanently, the aggregate long-run capital stock increases by about 3 percent and welfare measured by consumption increases by about 0.6 percent. This result is robust to small changes of parameter values and to several extensions of our baseline model.

Entrepreneurs face significant non-diversifiable business risks. In a dynamic incomplete-markets model of entrepreneurial finance, we show that such risks have important implications for their interdependent consumption/saving, portfolio choice, financing, investment, and endogenous default/cash-out decisions. Even though more risk-averse entrepreneurs default earlier for given debt service, they choose higher leverage ex ante for diversification benefits. Entrepreneurs demand not only a systematic risk premium but also an idiosyncratic risk premium due to the lack of diversification. We derive an analytical formula for the idiosyncratic risk premium whose key determinants are risk aversion, idiosyncratic volatility and the sensitivity of entrepreneurial value of equity with respect to cash flow. An entrepreneur’s option to use external equity improves diversification and raises the private value of firm, but it partially crowds out the value of diversification via external risky debt and hence lowers leverage. Finally, after debt is in place, when an entrepreneur chooses among mutually exclusive projects with different idiosyncratic volatilities, the effect of risk aversion tends to dominate the risk-shifting incentives. Only entrepreneurs with very low risk aversion engage in risk-shifting activities.

We put forward an equilibrium model that provides a link between the cross section of expected returns and book-to-market characteristics. We model two primitive assets: value assets, and growth assets that are options on assets in place. The cost of option exercise, which is endogenously determined in equilibrium, is highly procyclical and acts as a hedge against risks in assets in place. Consequently, growth options are less risky than value assets, and the model features a value premium. Our model incorporates long-run risks in aggregate consumption (as in Bansal and Yaron (2004)) and replicates the empirical failure of the conditional CAPM prediction. We calibrate the model and show that it is able to quantitatively account for the observed pattern in mean returns on book-to-market sorted portfolios, the magnitude of the CAPM-alphas, and other silent features of the cross-sectional data.

Empirical studies showed that firm-level volatility has been increasing but the aggregate volatility has been decreasing in the US for the post-war period. This paper proposes a unified explanation for these diverging trends. Our explanation is based on a story of financial development –measured by the reduction of borrowing constraints because of greater access to external financing and options for risk sharing. By constructing a dynamic stochastic general-equilibrium model of heterogenous firms facing borrowing constraints and investment irreversibility, it is shown that financial liberalization increases the lumpiness of firm-level investment but decreases the variance of aggregate output. Hence, the model predicts that financial development leads to a larger firm-level volatility but a lower aggregate volatility. In addition, our model is also consistent with the observed decline in volatility of private held firms which do not have (or have only limited) access to external funds.

This paper presents an analytically tractable continuous-time general equilibrium model with investment irreversibility and fixed adjustment costs. In the model, there is a continuum of firms that are subject to idiosyncratic shocks to capital. Although the presence of investment frictions lowers consumer welfare, it may raise or reduce the long-run average capital stock, depending on the degree of idiosyncratic uncertainty. An increase in this uncertainty may raise equilibrium aggregate capital, but reduce welfare. An unexpected permanent change in the corporate income tax rate affects the investment trigger and target values, and hence the size and rate of capital adjustment. Following this tax policy, the percentage changes in equilibrium quantities are larger when fixed adjustment costs are larger. These changes are significantly smaller in a general equilibrium model than in a partial equilibrium model.

This paper analyzes a risk averse entrepreneur’s real investment decision under incomplete markets. The entrepreneur smoothes his intertemporal consumption by investing in both a risk-free asset and a risky asset, which allows him to partially hedge against the project cash flow risk. We show that risk aversion lowers both the project value upon investment and the option value of waiting to invest through the precautionary saving effect. Furthermore, risk aversion delays investment since the project value is reduced more than the option value to invest. It is also shown that although hedging can reduce the cash flow risk, it may have a positive or negative return effect, depending on the correlation between the cash flow risk and the market. Consequently, investment timing is not monotonic with the extent of hedging opportunity. Finally, welfare implications of hedging are analyzed.

This paper studies the impact of cross-country variation in financial market development on firms’ financing choices and growth rates using comprehensive firm-level datasets. We document that in less financially developed economies, small firms grow faster and have lower debt to asset ratios than large firms. We then develop a quantitative model where financial frictions drive firm growth and debt financing through the availability of credit and default risk. We parameterize the model to the firms ’ financial structure in the data and show that financial restrictions can account for the majority of the difference in growth rates between firms of different sizes across countries.

This article develops a real options model to study the interaction of industry structure and takeovers. In an asymmetric industry equilibrium, firms have an endogenous incentive to merge when restructuring decisions are motivated by operating and strategic benefits. The model predicts that (i) merger activities are more likely in more concentrated industries or in industries that are more exposed to industrywide shocks; (ii) returns to merger and rival firms arising from restructuring are higher in more concentrated industries; (iii) increased industry competition delays the timing of mergers; and (iv) in sufficiently concentrated industries, bidder competition induces a bid premium that declines with product market competition.

Many economic decisions can be described as an option exercise or optimal stopping problem under uncertainty. Motivated by experimental evidence such as the Ellsberg Paradox, we follow Knight (1921) and distinguish risk from uncertainty. To afford this distinction, we adopt the multiple-priors utility model. We show that the impact of ambiguity on the option exercise decision depends on the relative degrees of ambiguity about continuation payoffs and termination payoffs. Consequently, ambiguity may accelerate or delay option exercise. We apply our results to investment and exit problems, and show that the myopic NPV rule can be optimal for an agent having an extremely high degree of ambiguity aversion. JEL Classification: D81, G31