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Product market efficiency: The bright side of myopic, uninformed, and passive external finance

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  • Thomas H. Noe
  • Michael J. Rebello
  • Thomas A. Rietz

Abstract

We show that introducing an external capital market with information asymmetry into a product market model reduces opportunistic substitution of sub-standard goods and encourages producers to concentrate on long-run reputation building. We test this result with a laboratory experiment. We find that, when the problem of product market opportunism is moderate, i.e., reputation formation equilibria exist when firms raise external funds but not when they rely on internal funds, external financing results in much higher (roughly double) economic surplus. This external finance premium results primarily from higher levels of output caused by the reduced likelihood or market failure.

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Bibliographic Info

Paper provided by Oxford Financial Research Centre in its series OFRC Working Papers Series with number 2008fe12.

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Length: 51
Date of creation: 2008
Date of revision:
Handle: RePEc:sbs:wpsefe:2008fe12

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Web page: http://www.finance.ox.ac.uk
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Keywords: adverse selection; financing; reputation;

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