Equilibrium and the Role of the Firm in Incomplete Markets

This paper studies the role of the firm in incomplete markets. Stock market equilibria are shown to exist generically in economies with “smooth” preferences and production sets. The set of equilibrium allocations is generically infinite. The stochastic setting is described by an arbitrary event tree. At each state and date agents trade on markets for spot commodities, common stocks, and other general securities. The goal of share value maximization by firms is shown to be generically strictly sub-optimal in equilibrium for all but (at most) a single shareholder. The Modigliani-Miller Invariance Principle, showing the irrelevance of the financial policy of the firm, is re-examined in the light of incomplete markets.