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

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  • Steven Grenadier
  • Andrey Malenko
  • Ilya A. Strebulaev

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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17945.

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Date of creation: Mar 2012
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Publication status: published as Investment, Reputation, and the Temptation to Blend in with the Crowd (co-authored with Steven R. Grenadier and Andrey Malenko) Journal of Financial Economics, 2014, 111, 137-157
Handle: RePEc:nbr:nberwo:17945

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