Theory of the Firm under Uncertainty: Financing, Attitude to Risk and Output Behavior

The paper examines the risk behavior of a competitive firm under price uncertainty. In the model developed in the paper we have departed from the thought-provoking approach of Greenwald and Stiglitz (1993a), which implies solely risk averse behavior of firms due to its restrictive assumptions about firm’s financing. Through the incorporation of other plausible and more general assumptions about the firm’s financing (namely the access to the equity market, possible existence of soft budget constraint) we were able to theoretically formulate the conditions, under which the firm is induced to behave in more risk averse vs. risky manner. While the firm’s attitude to risk directly influences its willingness to produce, our results indicate that in the environment of uncertainty the price and technology are not the only important determinants of the firm’s optimal output level as is the case for the neoclassical theory of firm. The results of our model have shown that additional factors like firm’s net worth position, sensitivity of managers to bankruptcy, firm’s ability to raise new equity, softness of the budget constraint and degree of uncertainty about the future prices may play an important role for firm’s optimal output considerations.