Agency-based asset pricing

We study an infinite-horizon Lucas tree model where a manager is hired to tend to the trees and is compensated with a fraction of the trees’ output. The manager trades shares with investors and makes an effort that determines the distribution of the output. When the manager is less risk-averse than the investors, managerial trading smoothes output and results in a less volatile stock price and a lower risk premium; when the manager is more risk-averse, output and the stock price become more volatile and the risk premium is higher. Trading between the manager and investors acts as an indirect renegotiation mechanism that dynamically modulates the manager’s incentives, and in the meantime, allocates risk and return, but its effectiveness is limited when the market consists of dispersed small investors. * We would like to thank Debbie Lucas, Randall Morck, Larry Samuelson, Feng Gao and seminar participants at Columbia University, the IMF, and Georgia State University for helpful comments and suggestions. § School of Management, Yale University, New Haven, CT 06520-8200. E-mail: [email protected]. §§ Tsinghua University, School of Economics and Management, Beijing 100084, China. E-mail: [email protected]. §§§ J. Mack Robinson School of Business, Georgia State University, Atlanta, GA 30303. Email: [email protected]. Gary B. Gorton Yale University and NBER Ping He Tsinghua University §§