Externalities and Corporate Investment

Journal of Banking and Finance, 2012, vol. 36, pp. 439-453 (Under the new name "Product Markets and Corporate Investment: Theory and Evidence")

41 Pages Posted: 2 Mar 2006 Last revised: 18 Feb 2022

See all articles by Evrim Akdoğu

Evrim Akdoğu

Sabanci University

Peter MacKay

Hong Kong University of Science & Technology (HKUST) - Department of Finance

Abstract

We show that investment patterns often associated with agency and information problems can emerge as rational responses to product-market rivalry. We establish this result using simultaneous and sequential models of innovative investment that balance two negative externalities. One externality arises when all competing firms invest, thus eroding the gains to innovation accruing to any one firm. Another externality arises when some firms do not invest and lose out to rivals who do innovate. The value of innovative investment therefore depends on the innovation's intrinsic value to each firm and the actions of all competitors. Our analysis can rationalize investment patterns that might appear suboptimal when these externalities are ignored. For instance, our simultaneous model can justify investment levels that might otherwise be interpreted as under or over-investment. Our sequential model shows that value-maximizing firms might optimally herd in their investment decisions. We present evidence supporting key aspects of both the simultaneous and sequential models.

Keywords: Investment, Externalities, Innovation, Competition

Suggested Citation

Akdoğu, Evrim and Mackay, Peter, Externalities and Corporate Investment. Journal of Banking and Finance, 2012, vol. 36, pp. 439-453 (Under the new name "Product Markets and Corporate Investment: Theory and Evidence"), Available at SSRN: https://ssrn.com/abstract=887220 or http://dx.doi.org/10.2139/ssrn.887220

Evrim Akdoğu (Contact Author)

Sabanci University ( email )

Istanbul
Turkey

Peter Mackay

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

Clear Water Bay, Kowloon
Hong Kong
852-2358-8319 (Phone)
852-2358-1749 (Fax)

HOME PAGE: http://www.bm.ust.hk/~fina/staff/pmackay.html

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