Theoretical models to better link corporate finance with asset pricing
There is a belief that these two approaches to financial activity should and can be examined within a unified framework. EU-funded researchers used this claim as a basis for the ACAP (Agency costs and asset pricing) project. The first part of the project focused on dynamic models of the firm. The aim was to derive security price methods from an accurate description of firms' operations and internal frictions. To this effect, project partners studied the effect of agency costs on firm size and investment. They investigated the impact of these agency costs on key financial variables, including stock and bond prices, leverage, book-to-market ratios, default risk and the holding of liquidities by firms. Results show that agency costs together with external financing costs can help to explain why stocks issued by firms are more volatile when their value is low rather than high. The second phase centred on nonexclusive contractual relationships in markets with participants that are informed in different ways. The ACAP team demonstrated that informed agents' ability to reliably communicate their confidential information is greatly restricted when privately contracting several trading partners at the same time. This leads to nonexclusive competition, resulting in a major market breakdown. Findings provide an understanding of the role played by structured financial products in the recent financial crisis. Researchers also examined which forms of regulatory intervention could help improve the efficiency of such nonexclusive markets. ACAP shed considerable light on how financial contracting deals with agency costs that are a result of conflicting sources of information between various stakeholders.
Keywords
Corporate finance, asset pricing, ACAP, agency costs
