Can Herding Improve Investment Decisions?

Abstract

Existing models show that herding in decisions can cause signicant information loss, inferior information aggregation and impaired decision making. However, we show that in a multi-stage decision setting with endogenous information production, herding on the initial decision can actually result in superior aggregate information and improved decisions. This is because the possibility of herding by a follower incentivizes the leader to increase its ex-ante information production to an extent that it can dominate the information loss from herding. Examples include decisions to enter new markets, fund R&D, and provide early-stage venture capital.

Keywords: herding, entry, information, cascades, innovation, venture capital

JEL Classification: D80, G20, G30