Equilibrium investment and asset prices under imperfect corporate control

Dow, J, Gorton, G and Krishnamurthy, A (2005) Equilibrium investment and asset prices under imperfect corporate control. Working Paper. London Business School IFA Working Paper.

Abstract

We integrate a widely accepted version of the separation of ownership and control 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 behaviour of interest rates and the yield curve. The ficial friction causes cashflow 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.