Shareholders Unanimity With Incomplete Markets

When financial markets are incomplete, shareholders will in general disagree on the optimal level of investment to be undertaken by the firm (Grossman and Hart, 1979). Macroeconomic models with heterogeneous agents and incomplete markets (e.g. Krusell and Smith, 1998) usually ignore this issue by assuming that consumers, rather than firms, make the decision to accumulate capital. This assumption, while convenient, is in general without loss of generality only if the asset market is complete. This paper derives conditions under which shareholders unanimity obtains in equilibrium despite the incompleteness of the asset market. In the model economy analyzed here consumers face idiosyncratic labor income risk and the only asset they have access to is the stock of the representative firm. The firm (i.e. its shareholders) decides how much of its earnings to invest in physical capital and how much to distribute as dividends. The rate of return on capital is random. The main result of the paper is that, if the firm's production function exhibits constant returns to scale, then in a competitive equilibrium shareholders will unanimously agree on the optimal level of investment. As a result, in this incomplete markets economy the equilibrium stock price of the firm is always equal to its capital stock, just as in a complete markets setting. However, the equilibrium level of the capital stock differs from what is obtained under complete markets.