Hypotheses Development and Empirical Predictions Sample Clauses

Hypotheses Development and Empirical Predictions. Imagine a firm whose manager makes decisions that affect the firm’s value. The manager always seeks to make decisions that maximize the value of the firm, but investors may disagree that a particular decision is value-maximizing. If investors agree with the manager, they value the firm at VG, and if they disagree they value it at VB < VG. The probability that an investor group i will agree with the manager is ▇▇. Thus, investors group i assigns a value Vi to the firm, where Vi = ρi VG + (1 – ρi ) VB Either due to wealth endowment constraints or risk aversion or both, each investor group i holds a limited fraction of the firm’s shares. Thus, in equilibrium the firm will be held by investors with different agreement parameters, ρi. The lowest agreement parameter will be that of the marginal group of investors, with inframarginal investors having higher values of ρi. It is clear that Vi is strictly increasing in ρi. For simplicity, assume that the amount of wealth invested in the firm by any investor group is the same across all investor groups that are long in the stock9, and that the distribution of the mass of investors is uniform across ρ C [ρ0, ρmax], where ρ0 is the ρ of the marginal investor in the stock and ρmax is the ρ of the investor with the highest ρ in the stock. The firm’s stock price will then be: V0 = ρ0 VG + (1– ρ0) VB Let B(·) be the benefit to the firm that the manager perceives from increasing the agreement of the marginal investor. That is, if the firm repurchases stock at the prevailing 9 This assumption is reasonable if investors are risk neutral and wealth constrained with equal wealth endowments. More generally, we would expect investors with higher ρ’s to invest more. However, the results are even stronger with that specification. market price V0 or a slightly higher price, the first shareholders to sell will be the marginal investors with ρ = ρ0, and then as the firm repurchases increasing amounts, it will have to pay higher prices in order to induce investors with higher value of ρ to sell. A repurchase will lead to the post-repurchase ρ of the new marginal investors, call it ρ*, being higher than ρ0, the pre-repurchase ρ of the marginal investors. Thus, the increase in ρ due to a repurchase in which $C is spent on the repurchase is 6ρ (C, ρ0) = ρ*(C) – ρ0 We assume that B(·) is an increasing and concave function of 6ρ and that ρ*(C) is increasing in C. Viewing C as an investment in the repurchase, the firm chooses C to maximize i...