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Time-Consistent Agents, Time-Inconsistent Firms: Investment in Heterogeneous-Agent Economies


Abstract: This paper studies firms' investment decisions in heterogeneous-agent economies with trading frictions in financial markets. Shareholders have time-consistent preferences but disagree on the timing of dividends. As a consequence, the firm’s problem is endogenously time-inconsistent: the firm behaves as if it faces quasi-hyperbolic discounting, opening a corporate discount-rate wedge between the rate at which it discounts investment and its financial cost of capital. In a calibrated economy, larger trading frictions imply lower capital but only when firms cannot commit to an investment policy. In contrast, if firms can commit, trading frictions affect asset prices but have little effect on aggregate capital. Consistent with the mechanism, firms whose equity is less liquid apply larger wedges in the data. Moreover, firms' ability to commit materially changes aggregate-shock transmission: without commitment, the wedge varies over time, so the risk-free rate alone is not a sufficient statistic for investment incentives.

JEL Classification: E44; G32; G12; D15;

https://doi.org/10.20955/wp.2022.022

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Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2026-10-04

Number: 2022-022

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