Incentives for Information Production in Markets Where Prices Affect Real Investment

43 Pages Posted: 15 Jan 2007 Last revised: 7 Dec 2011

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

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Abstract

A fundamental role of financial markets is to gather information on firms' investment opportunities, and so help guide investment decisions. In this paper we study the incentives for information production when prices perform this allocational role. If firms 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 ex ante. Based on this insight, we derive the following main results. (1) Strategic complementarities in information production may arise, leading to multiple equilibria with different levels of information. (2) The incentive to produce information decreases when economic fundamentals deteriorate, leading to an amplification of shocks to fundamentals. (3) Incentives to produce information on assets in place are stronger than for new investment opportunities. (4) Firms will attract more information production and improve their ex-ante value by committing to overinvest.

Keywords: Information Production, Real Investments, Financial Markets

Suggested Citation

Dow, James and Goldstein, Itay and Guembel, Alexander, Incentives for Information Production in Markets Where Prices Affect Real Investment. UBC Winter Finance Conference 2008 Paper. Available at SSRN: https://ssrn.com/abstract=956797 or http://dx.doi.org/10.2139/ssrn.956797

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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