SFB 303 Discussion Paper No. A - 222

Author: DeMarzo, Peter, and Darrell Duffie
Title: Corporate Financial Hedging with Proprietary Information
Abstract: This paper is based on the idea that the elimination of noise in a firm's dividend stream is unanimously supported by shareholders. In order to make succinct statements, however, we basically rely on the strong assumption that dividends include noise (with respect to the information available to shareholders) that is spanned by financial markets, given the information known to the firm. Our conclusions are thus related to the intuition of the spanning literature on unanimity of production decisions, beginning with Diamond (1967) and Ekern and Wilson (1974). The remainder of the paper proceeds as follows: Section 2 outlines the primitive notions in the model in a simple two-period setting under uncertainty. In order to provide some contrasting background to our results, Section 3 reviews the standard MM theory in our setting. Section 4 presents the basic idea we have to offer in the bluntest possible terms; hopefully the reader will find the assumptions in the later sections more palatable. Section 5 presents our notion of unanimously supported corporate financial hedging strategies. In Section 6, which could be viewed as the principle body of our results, we present unanimously supported hedging strategies in various settings. Finally, Section 7 shows that when firms adopt such financial hedging policies, the resulting equilibrium allocations are in fact constrained Pareto optimal.
Creation-Date: January 1989
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