Commitment to Overinvest and Price Informativeness

40 Pages Posted: 15 Nov 2005

See all articles by James Dow

James Dow

London Business School - Institute of Finance and Accounting

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department

Alexander Guembel

Toulouse School of Economics, University of Toulouse Capitole

Date Written: January 16, 2006

Abstract

A fundamental role of financial markets is to gather information on firms' investment opportunities, and so help guide investment decisions in the real sector. We argue in this paper that firms' overinvestment is sometimes necessary to induce speculators in financial markets to produce information. If firms always cancel planned investments following poor stock market response, the value of their shares will become insensitive to information on investment opportunities, so that speculators will be deterred from producing information. We discuss several commitment devices firms can use to facilitate information production. We show that the mechanism studied in the paper amplifies shocks to fundamentals across stages of the business cycle.

Keywords: Allocational Role of Price, Overinvestment, Price Informativeness, Business Cycles, Real Options, Financial Slack, Corporate Governance

JEL Classification: G14, G31

Suggested Citation

Dow, James and Goldstein, Itay and Guembel, Alexander, Commitment to Overinvest and Price Informativeness (January 16, 2006). EFA 2006 Zurich Meetings Paper. Available at SSRN: https://ssrn.com/abstract=846245 or http://dx.doi.org/10.2139/ssrn.846245

James Dow

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
+44 20 7262 5050 (Phone)
+44 20 7724 3317 (Fax)

Itay Goldstein (Contact Author)

University of Pennsylvania - The Wharton School - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-746-0499 (Phone)

Alexander Guembel

Toulouse School of Economics, University of Toulouse Capitole ( email )

Manufacture des Tabacs
21, allee de Brienne
Toulouse, 31000
France

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