DP3348 Decentralizing the Stochastic Growth Model

Author(s): Jean-Pierre Danthine , John B Donaldson

Publication Date: April 2002

Keyword(s): stochastic growth model , business cycles , delegated management

JEL(s): E32 , E44

Programme Areas: Financial Economics

Link to this Page: www.cepr.org/pubs/dps/DP3348.asp

The objective of this Paper is to propose a number of alternative decentralized interpretations of representative agent style stochastic growth economies and to explore their implications for the generality of this model construct. Under our first interpretation, firms exist forever and undertake all multi-period investment decisions while consumer-worker-investors only own financial claims to the firm’s output. This contrasts with the more standard decentralization approach where firms exist on a period-by-period basis and consumer-worker--investors have direct title to the economy’s capital stock. Under our second interpretation shareholders hire a manager who undertakes the firm’s investment decisions in conformity with his incentive contract. The time series properties of the shareholder-manager economy are seen to replicate those of the analogous representative agent economy if and only if the manager’s contract assumes a specific form. This suggests the time series properties of an economy where incentive contracts such as stock option plans are pervasive will differ from those of more standard real business cycle models.