Investment Busts, Reputation, and the Temptation to Blend in with the Crowd
Steven R. Grenadier
Stanford Graduate School of Business
MIT Sloan School of Management
Ilya A. Strebulaev
Stanford University - Graduate School of Business; National Bureau of Economic Research
May 28, 2013
Journal of Financial Economics (JFE) 111(1): 137-157, January 2014
AFA 2013 San Diego Meetings Paper
Rock Center for Corporate Governance at Stanford University Working Paper No. 115
We provide a real-options model of an industry in which agents time abandonment of their projects in an effort to protect their reputations. Agents delay abandonment attempting to signal their quality. When a public common shock forces abandonment of a small fraction of projects irrespective of agents' quality, many agents abandon their projects strategically even if they are unaffected by the shock. Such "blending in with the crowd" effect creates an additional incentive to delay abandonment ahead of the shock, leading to accumulation of "living dead" projects, which further amplifies the shock. The potential for moderate public common shocks often improves agents' values.
Keywords: abandonment, real options, signaling, asymmetric information, reputation
JEL Classification: D81, D82, G31, G33
Date posted: March 20, 2012 ; Last revised: November 26, 2014
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