Essays On Asset Pricing And Firm Dynamics

Abstract

My dissertation studies the implications of agency frictions for asset prices and firm dynamics. The first chapter embed an optimal contracting framework into an otherwise standard asset pricing paradigm to resolve some of the challenges in investment and asset pricing literature. The second chapter investigates the effect of agency frictions on CEO compensation, firm size and investment dynamics. In Chapter one "A Dynamic Agency Based Asset Pricing Model with Production", we develop a general equilibrium model based on dynamic agency theory to study investment and asset prices. In our environment, neither firms nor workers can commit to compensation contracts that provide continuation values below their outside options. At the aggregate level, the presence of agency frictions amplifies the market price of risks and allows our model to generate a sizable equity premium with a low level of risk aversion. History dependent labor contracts generate a form of operating leverage and allow our model to match the key features of the aggregate and cross-section of investment and equity returns in the data. A variance decomposition of investment into discount rate news and cash flow news supports the mechanism of our model. In Chapter two, "Firm Dynamics under Limited Commitment", we present a general equilibrium model with twosided limited commitment that helps account for the observed heterogeneity in firms’ investment, payout and CEO-compensation policies. In the model, shareholders cannot commit to holding negative net present value projects, and managers cannot commit to compensation plans that yield life-time utility lower than their outside options. Firms operate identical constant return to scale technologies with i.i.d. productivity growth. Our model endogenously generates power laws in firm size and CEO compensation and explains the differences in their empirical distributions. We also show that the model is able to quantitatively account for the salient features of firms’ growth dynamics, the observed negative relationship between firms’ investment rate and size, and the positive relationship between firms’ size and their dividend and CEO payout.