## ASSET PRICING MODEL: Coordination failures

Precarious employment relationships hurt long-term savings and equity investments

In this section only, assume that consumers, whose mass is 1, must consume some “subsistence level” (food, education, housing, etc.) at the intermediate date. That is, we replace the utility

Consumers thus care about the consumption path as well as its level.

The representative firm’s investment cost at date 0 is normalized at I = 1. As before, assume that consumers have enough of the nonstorable good at date 0 to help finance the initial investment I. The firm’s income at date-1 has two possible values: high income ж я with probability /я, and low income xl with probability /t = 1 — /я, where

Assumptions (31) and (33) imply that consumers do not value liquidity at date 1 provided that they know that they will have a job at date 1.

Continuation yields a private benefit В to the entrepreneur, and a verifiable (pledgeable) income X. Assume В + X > w so that continuation is optimal.24 As well, assume that

With these parameter restrictions there is a feedback between aggregate liquidity and the maturity of savings such that multiple equilibria can arise.

• A long-maturity, high-liquidity, high-employment equilibrium.

Suppose, first, that all firms continue at date 1 in both states of nature. All consumers then have a job at date 1 and receive a wage w. By (31) and (33) they have no demand for liquidity and are thus willing to defer all payments on their date-0 investment to date 2.

Since the corporate sector need not meet any short-term payment obligations, it always has enough liquidity to pay the date-1 wage w, as xl + X > w from (35). Conditions (35) and (36) then imply that the firms can repay date-0 investors out of X since —I + {/нхн + Ilxl) + X — w > 0. In this (efficient) equilibrium the corporate sector issues long-term claims and does not lay off workers.

• A short-maturity, low-liquidity, low-employment equilibrium.

Suppose instead that firms are unable to continue in the bad state of nature. Consumers become unemployed and because they have to to consume c1; they will insist on receiving at least c1 in this bad state of nature. Therefore, they want to hold short-term claims on firms. Condition (32) guarantees that this is indeed feasible, while (34) and (36) imply that given that workers are paid c1, firms no longer have any cash to finance the reinvestment. Firms continue only in the good state of nature, and equation (36) assures that such a plan can be financed at date 0.