Economists use agency theory to study problems related to motivating and controlling cooperative action. Principals, especially in corporate organizations, require agents to conduct business and seek planned outcomes. Agents themselves, thus, must be motivated through incentives to perform for principals. Agency theory argues that shareholder interests require protection that is provided through a separation of roles between the board of directors and executive management. In contrast, the stewardship theory of corporate governance holds that shareholder interests are maximized by integrating the roles of these two bodies.
Arbitrage pricing may be used to minimize return risk (the risk associated with an anticipated return on financial assets). Arbitrage pricing requires that arbitrage opportunities not be present in a market (information is complete and widely shared). In such an arbitrage-free environment, a financial manager can determine the arbitrage market price of a commercial loan or credit derivative as the expected net present value of the cash flows it generates. An in any net present value exercise, the selection of the discount rate is crucial.
The Efficient Market Hypothesis holds that at any given time, financial asset prices fully reflect all available information. The hypothesis implies, thus, that all investors have access to all relevant information and that all investors use that information. If the efficient market hypothesis is true, then asset bubbles and subsequent crashes should not occur. Because such events do occur, however, reflects the real world in which (a) all investors do not always have access to all relevant information and in which (b) not all investors with access to all relevant information use such information.
The random walk hypothesis, which concluded that stock price changes were similar to a random series, eventually, evol
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