This text presents the perfect capital market model and the associated Fisher separation theorem. This model demonstrates that utility maximizing and perfectly rational owners will agree on forcing the managers of the firms they own to pursue the profit-maximizing strategy. This is so for diverse time-preferences among the owners as long as capital markets are perfect. There are no direct transaction costs, regulation or taxes, and all assets are perfectly divisible. Perfect competition in product and securities markets.
All agents receive information simultaneously and it is costless.
The information is either certain or risky. The agents in the economy may choose to buy stocks in a firm that has four investment projects at its disposal. The outlays and returns on these projects are displayed in figure I below. A manager is hired by the agents to run the firm. From the numbers, it is clear that there is a decreasing return to scale on investments.