By R. Glenn Hubbard
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Extra info for Asymmetric Information, Corporate Finance, and Investment (National Bureau of Economic Research Project Report)
The investment function of equation (3) can thus be rewritten as (5) where bt represents the level of rationed credit and hb > O. Extending the circulating capital model to incorporate investment in longlived physical capital is principally a matter of redefining the production period. Consider a firm whose sole investment project consists of a plant with a fixed life of T periods. Assume for simplicity that funds borrowed to support the plant are due to be repaid (including accrued interest) at the end of period T, that input costs and output revenues are contemporaneous in each subperiod t = 1, .
36. This consumption function, which is common to traditional macroeconomic models, is used for the sake of simplicity. A full general equilibrium model with intertemporal consumer utility maximization is developed in Greenwald and Stiglitz (1986). A model with a consumption function modified to take account of permanent income in a rational expectations context is developed in Greenwald and Stiglitz (1988). Another general equilibrium alternative is developed by Woodford (1986), who incorporates endogenous borrowing constraints.
One important qualification must, however, be made to this simple description. When the consequences of actions are particularly uncertain, and firms are particularly risk averse, it is sometimes suggested that firms will simply maintain the status quo. But what does it mean to continue doing what you were doing before? Does it mean keeping absolute prices fixed, or relative prices? Absolute wages, or relative wages? We provide here an answer: very risk-averse firms will take those actions that minimize the variability of their profits.
Asymmetric Information, Corporate Finance, and Investment (National Bureau of Economic Research Project Report) by R. Glenn Hubbard