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

46 Pages Posted: 31 Mar 2012 Last revised: 27 Oct 2014

See all articles by Steven R. Grenadier

Steven R. Grenadier

Stanford Graduate School of Business

Andrey Malenko

University of Michigan, Stephen M. Ross School of Business; Centre for Economic Policy Research (CEPR)

Ilya A. Strebulaev

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

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Date Written: March 2012

Abstract

We provide a dynamic model of an industry in which agents strategically time liquidation decisions in an effort to protect their reputations. As in traditional models, agents delay liquidation attempting to signal their quality. However, when the industry faces a common shock that indiscriminately forces liquidation of a subset of projects, agents with bad enough projects choose to liquidate even if their projects are unaffected by the shock. Such "blending in with the crowd" creates an additional incentive to delay liquidation, further amplifying the shock. As a result, even minuscule common shocks can be evidenced by massive liquidations. As agents await common shocks, the industry accumulates "living dead" projects. Surprisingly, the potential for moderate negative common shocks often improves agents values.

Suggested Citation

Grenadier, Steven R. and Malenko, Andrey and Strebulaev, Ilya A., Investment Busts, Reputation, and the Temptation to Blend in with the Crowd (March 2012). NBER Working Paper No. w17945, Available at SSRN: https://ssrn.com/abstract=2031933

Steven R. Grenadier (Contact Author)

Stanford Graduate School of Business ( email )

Graduate School of Business
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Andrey Malenko

University of Michigan, Stephen M. Ross School of Business ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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Ilya A. Strebulaev

Stanford University - Graduate School of Business ( email )

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

National Bureau of Economic Research ( email )

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