Systematic Risk and the Theory of the Firm

The mean-variance capital-asset-pricing model forms the basis for much of the theoretical and empirical work in modern financial economics. While this model defines the relevant measure of the risk of a security β in a general equilibrium context, the relationship between this measure and the microeconomic variables of a firm has not been studied in the literature. This paper develops a model of the firm under uncertainty and derives the relationship between systematic risk and such firm variables as monopoly power, demand elasticity, and the labor-capital ratio. The general conclusions are surprisingly robust and point to several interesting empirically testable hypotheses.