Optimal conjectures: Implications for finance and taxation

This dissertation explores the hypothesis that an oligopolistic firm uses its conjecture of interdependence as an instrument of profit maximization. Conjectures so formed are optimal conjectures and are shown to be consistent. The dissertation develops the theory of optimal conjectures, and derives its implications for three topics in finance and taxation. (1) The optimal incentive structure for the manager of an oligopolistic firm turns out to be profit, rather than a linear combination of profit and sales. This result obtains when managers in the industry have optimal conjectures about each other. The conventional wisdom that sales should be a part of manager's incentive structure thus depends on a kind of non-rational managerial behavior. (2) In an oligopolistic market with optimal conjectures, the value of a firm is again independent of its financial leverage. This finding contrasts with the conclusion of recent studies that Cournot oligopolists have well-defined value-maximizing capital structures. (3) Tax can increase a firm's profits, when firms form optimal conjectures. Because tax affects perception of interdependence, it may increase collusion, However, social welfare after tax remains higher if firms hold optimal conjectures than if they hold Cournot conjectures.