Bart Lambrecht (University of Cambridge)

Optimal Financial Policies for a Group

Abstract. We model the financial policies of a private firm owned by a group of undiversified investors with heterogeneous capital contributions and risk preferences. The first-best expected life-time utility for each investor can be achieved by issuing financial claims resembling preferred stock with heterogeneous dividend caps and common stock, and by following procyclical investment and financing policies. These optimal financial policies and claims can be derived as the solution to a social planner problem that maximizes a weighted average of investors’ life-time utility. Investors’ utility weights are fixed at startup and determined by their participation constraints.