Investment Busts, Reputation, and the Temptation to Blend in with the Crowd

Posted: 20 Mar 2012 Last revised: 26 Nov 2014

Steven R. Grenadier

Stanford Graduate School of Business

Andrey Malenko

MIT Sloan School of Management

Ilya A. Strebulaev

Stanford University - Graduate School of Business; National Bureau of Economic Research

Multiple version iconThere are 2 versions of this paper

Date Written: May 28, 2013

Abstract

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

Suggested Citation

Grenadier, Steven R. and Malenko, Andrey and Strebulaev, Ilya A., Investment Busts, Reputation, and the Temptation to Blend in with the Crowd (May 28, 2013). Journal of Financial Economics (JFE) 111(1): 137-157, January 2014; Rock Center for Corporate Governance at Stanford University Working Paper No. 115; AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2022107 or http://dx.doi.org/10.2139/ssrn.2022107

Steven R. Grenadier

Stanford Graduate School of Business ( email )

Graduate School of Business
Stanford, CA 94305-5015
United States
650-725-0706 (Phone)
650-725-6152 (Fax)

Andrey Malenko (Contact Author)

MIT Sloan School of Management ( email )

100 Main Street
E62-619
Cambridge, MA 02142
United States
617-225-9301 (Phone)

HOME PAGE: http://www.mit.edu/~amalenko

Ilya A. Strebulaev

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

HOME PAGE: http://faculty-gsb.stanford.edu/strebulaev/

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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