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Corporate Investment under Uncertainty and Pareto Optimality in the Capital Markets

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  • Michael C. Jensen
  • John B. Long Jr.

Abstract

Within the context of a mean-variance equilibrium model of the pricing of capital assets, this paper investigates the allocation of investment in new risky opportunities which results from the collective behavior of firms, each of which attempts to maximize the net increase in its market value. This allocation is then compared to those allocations which (1) maximize nominal social wealth or (2) maximize social welfare. These comparisons are made under a variety of assumptions concerning the nature of the new opportunities, investor attitudes toward risk, and the number and characteristics of firms in the economy. With the exception of certain special cases, it is found that the private allocation of investment does not correspond to that which either maximizes social wealth or maximizes social welfare.

Suggested Citation

  • Michael C. Jensen & John B. Long Jr., 1972. "Corporate Investment under Uncertainty and Pareto Optimality in the Capital Markets," Bell Journal of Economics, The RAND Corporation, vol. 3(1), pages 151-174, Spring.
    • Handle: RePEc:rje:bellje:v:3:y:1972:i:spring:p:151-174
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    Cited by:

    1. Claus Dierksmeier, 2020. "From Jensen to Jensen: Mechanistic Management Education or Humanistic Management Learning?," Journal of Business Ethics, Springer, vol. 166(1), pages 73-87, September.
    2. Luis H. B. Braido & V. Filipe Martins†da†Rocha, 2018. "Output Contingent Securities And Efficient Investment By Firms," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 59(2), pages 989-1012, May.
    3. Hayne E. Leland, 1974. "Production Theory and the Stock Market," Bell Journal of Economics, The RAND Corporation, vol. 5(1), pages 125-144, Spring.
    4. Merton, Robert C., 1993. "On the microeconomic theory of investment under uncertainty," Handbook of Mathematical Economics, in: K. J. Arrow & M.D. Intriligator (ed.), Handbook of Mathematical Economics, edition 4, volume 2, chapter 13, pages 601-669, Elsevier.
    5. William J. Marshall & Jess B. Yawitz & Edward Greenberg, 1984. "Incentives for Diversification and the Structure of the Conglomerate Firm," NBER Working Papers 1280, National Bureau of Economic Research, Inc.
    6. James E. Smith, 2004. "Risk Sharing, Fiduciary Duty, and Corporate Risk Attitudes," Decision Analysis, INFORMS, vol. 1(2), pages 114-127, June.
    7. Rajnish Mehra, 2013. "Asset Pricing Implications of Macroeconomic Interventions An Application to Climate Policy," NBER Working Papers 19146, National Bureau of Economic Research, Inc.
    8. Tom Arnold & Richard Shockley, 2010. "Real Options Analysis and the Assumptions of Corporate Finance: A Non-Technical Review," Multinational Finance Journal, Multinational Finance Journal, vol. 14(1-2), pages 29-71, March-Jun.

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