Asymmetric Information and Irreversible Investments: An Auction Model

35 Pages Posted: 26 Jun 2015

See all articles by Joril Maeland

Joril Maeland

NHH Norwegian School of Economics - Department of Finance

Date Written: June 25, 2015

Abstract

The owner of a real option does not have the necessary expertise to manage the investment project and needs to contract with an expert in order to exercise the real option. The potential managers (the experts) have private information about their respective cost of investing in the project. The project owner organizes an auction in which the experts participate. The winner of the contract is the expert who can exercise the investment project at the lowest cost. The optimal contract is incentive compatible, i.e., it induces the winner to follow the investment strategy preferred by the project owner. It is shown that private information increases the project owner's cost of exercising the option, which may lead to under-investment. The inefficiency due to under-investment decreases in the number of experts participating in the auction.

Keywords: real options; investment strategy; private information; auction

JEL Classification: G31, D82, G13

Suggested Citation

Maeland, Joril, Asymmetric Information and Irreversible Investments: An Auction Model (June 25, 2015). Multinational Finance Journal, Vol. 14, No. 3/4, p. 255-289, 2010. Available at SSRN: https://ssrn.com/abstract=2622945

Joril Maeland (Contact Author)

NHH Norwegian School of Economics - Department of Finance ( email )

Helleveien 30
N-5045 Bergen
Norway

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