Corporate Investment under Uncertainty and Pareto Optimality in the Capital Markets

• Published in: Bell Journal of Economics and Management Science Vol. 3; no. 1; pp. 151 - 174
• Main Authors: Jensen, Michael C., Long, John B.
• Format: Journal Article
• Language: English
• Published: Mount Morris, Ill American Telephone and Telegraph Company 01-04-1972; Rand Corp
• Subjects: Business structures; Capital investments; Capital markets; Cash flow; Corporate investments; Financial investments; Investment risk; Investment value; Investors; Wealth
• ISSN: 0005-8556; 0741-6261; 2325-5323
• DOI: 10.2307/3003074

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.