Author's personal copy Review of Economic Dynamics 13 (2010) 537–558 Contents lists available at ScienceDirect Review of Economic Dynamics www.elsevier.com/locate/red Owning capital or being shareholders: An equivalence result with incomplete markets ✩ Eva Carceles-Poveda a,∗ , Daniele Coen-Pirani b a Department of Economics, State University of New York, Stony Brook, NY 11794-4384, United States b Tepper School of Business, Carnegie Mellon University, Pittsburgh, PA 15217, United States article info abstract Article history: Received 10 September 2008 Revised 8 July 2009 Available online 7 August 2009 JEL classification: D52 E44 G12 L20 Keywords: Incomplete markets Firm objectives Value maximization Many recent papers in macroeconomics have studied the implications of models with household heterogeneity and incomplete financial markets under the assumption that households own the stock of physical capital and undertake the intertemporal investment decisions. In these models, production exhibits constant returns to scale, households maximize expected discounted utility, and firms rent capital and labor from households to maximize period by period profits. This paper considers the case in which infinitely lived firms, rather than households, make the intertemporal investment decisions. Under this assumption, it shows that there exists an objective function for firms that results in the same equilibrium allocation as in the standard setting with one period lived firms. The objective requires that firms maximize their asset value, which is defined as the discounted value of future cash flows using present value processes that do not allow for arbitrage opportunities. © 2009 Elsevier Inc. All rights reserved. 1. Introduction Dynamic stochastic general equilibrium models with an infinite horizon and incomplete financial markets have been used extensively in the macroeconomic literature to study a variety of issues (see e.g. Aiyagari, 1994 and Krusell and Smith, 1997, 1998). In these models, an homogeneous output good is produced with a constant returns to scale technology that uses capital and labor. Firms rent these two inputs from households to maximize short-run (period by period) profits, while households own and accumulate the stock of physical capital. In contrast, the traditional general equilibrium literature with incomplete financial markets (GEI henceforth) models the firm as an infinitely lived entity that owns and accumulates its capital stock and is owned by its shareholders, who trade eq- uity shares in a stock market rather than accumulating physical capital (see Magill and Quinzii, 1996, Chapter 6, for a review of this literature). Whereas this provides a more realistic description of the intertemporal behavior of firms, an important result of the GEI literature is that there can be disagreement among shareholders on the path of capital accumulation that ✩ This paper has been circulated previously under the title “Capital Ownership under Market Incompleteness: Does it matter?”. We are very grateful to Michael Magill, Tom Muench, Herakles Polemarchakis, Yair Tauman, and Harald Uhlig for fruitful discussions on the topic. We also thank an anonymous referee for useful comments and suggestions. The paper has also benefited from comments of conference participants at the Meetings of the Society for the Advancement in Economic Theory, the NBER Summer Institute, the Econometric Society and the Conference on Computational Economics and Finance, as well as seminar participants at Arizona State, Atlanta Fed, the Fed’s Board of Governors, CEMFI, Duke, Goethe University at Frankfurt, Nova de Lisboa, North Carolina State, Rochester, University of Bilbao and University of Marne la Valle. * Corresponding author. E-mail addresses: ecarcelespov@notes.cc.sunysb.edu (E. Carceles-Poveda), coenp@andrew.cmu.edu (D. Coen-Pirani). URLs: http://ms.cc.sunysb.edu/~ecarcelespov/ (E. Carceles-Poveda), http://www.andrew.cmu.edu/user/coenp/res.htm (D. Coen-Pirani). 1094-2025/$ – see front matter © 2009 Elsevier Inc. All rights reserved. doi:10.1016/j.red.2009.08.001