An informational theory of the dynamic value of the firm

Abstract

This paper formulates an informational theory of the evolving value of the firm under uncertainties and unknowns in the future payoff structures. In general, the horizon of business firms would last for an indefinitely long period of time, and events in the considerably far future are intrinsically unknown. The existing study of indefinite horizon firms often relies on the assumption of time-invariant structures for the derivation of an optimal solution. In this paper, information about the firm’s future payoffs will be revealed as time goes by. The firm will revise its strategies accordingly, and the process will continue indefinitely. This new approach for the analysis of infinite horizon firms via information updating provides a more realistic and practical alternative to the study of the dynamic value of the firm. Finally, information-based option pricing formulae and non-random walks and cycles in asset price can also be generated with this theory.