The effects of costly exploration on optimal investment timing
AbstractThis paper investigates a principal-agent model in which an owner (principal) optimizes a contract with a manager (agent) delegated to undertake an investment project. In the model, we explore the effects of costly exploration by which the manager learns the real value of development cost. We show that high exploration cost can lead to a pooling policy not contingent on project type. Further, and more notably, we show that, in the presence of asymmetric information, higher exploration cost leads to wealth transfer from owner to manager and can then play a positive role in preventing a greedy contract by the owner and improving social welfare.
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Bibliographic InfoPaper provided by Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP) in its series Discussion Papers in Economics and Business with number 10-27.
Length: 24 pages
Date of creation: Nov 2010
Date of revision:
Real Options; Asymmetric Information; Costly Learning; Sequential Investment; Incentive Theory;
Find related papers by JEL classification:
- D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-12-04 (All new papers)
- NEP-CTA-2010-12-04 (Contract Theory & Applications)
- NEP-PPM-2010-12-04 (Project, Program & Portfolio Management)
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