Costly Learning and Agency Conflicts in Investments Under Uncertainty

54 Pages Posted: 16 Mar 2012 Last revised: 21 May 2013

See all articles by Lin William Cong

Lin William Cong

Cornell University; University of Chicago - Booth School of Business

Date Written: April 1, 2013


This paper studies endogenous learning and investment timing of managers in decentralized firms. While the "option to wait" in traditional real options models only concerns future uncertainties, another important source of managerial flexibility is the resolution of past uncertainties through costly effort, which mitigates investment inefficiencies caused by incomplete information. In equilibrium, timing of learning is crucial, and optimal strategies generally involve sequential thresholds for learning and investing. Moreover, costly learning naturally leads to information asymmetry between managers and outside investors, and managerial contracts are needed to incentivize learning and truthful reporting. The inherent agency conflicts distort investment behavior significantly, accelerating learning and high value projects while delaying low value projects. The distortions are costly to the investors and social welfare, and are sensitive to contractibility and cost of learning, as well as other fundamental characteristics of the market. In particular, with low market volatility or sufficient pledgeable liquidity for managers, contracting on learning restores investment efficiency. Among other implications, the model predicts that based on observed investment costs alone, projects appear delayed in general.

Keywords: Real options, Learning, Contracting, Asymmetric information, Agency

JEL Classification: D81, D82, D83, G13

Suggested Citation

Cong, Lin, Costly Learning and Agency Conflicts in Investments Under Uncertainty (April 1, 2013). Available at SSRN: or

Lin Cong (Contact Author)

Cornell University ( email )

Ithaca, NY 14853
United States

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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