Joshua Mitts

What Can we Learn from Stock Prices?: Cash Flow, Risk, and Shareholder Welfare

Volume 175 () / Issue 1, pp. 178-195 (18)

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Price is expected cash flows discounted at the risk-free rate plus an additional discount for risk exposure. Price equivalency does not always imply welfare equivalency: shareholders are not necessarily indifferent between a price increaseof $1 from higher cash flows and the same $1 increase from lower risk exposure. Even in complete markets, if managers enjoy private benefits of control, the social planner may prefer lower risk exposure to a price-equivalent increase in firm value from greater investor protection. This has implications for event studies, the trade-off between principal costs and agency costs, and the link between macroeconomic risk and corporate governance.

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