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Investment busts, reputation, and the temptation to blend in with the crowd

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  • Grenadier, Steven R.
  • Malenko, Andrey
  • Strebulaev, Ilya A.

Abstract

We provide a real-options model of an industry in which agents time abandonment of their projects in an effort to protect their reputations. Agents delay abandonment attempting to signal quality. When a public common shock forces abandonment of a small fraction of projects irrespective of agents' quality, many agents abandon their projects strategically even if they are unaffected by the shock. Such “blending in with the crowd” effect creates an additional incentive to delay abandonment ahead of the shock, leading to accumulation of “living dead” projects, which further amplifies the shock. The potential for moderate public common shocks often improves agents' values.

Suggested Citation

  • Grenadier, Steven R. & Malenko, Andrey & Strebulaev, Ilya A., 2014. "Investment busts, reputation, and the temptation to blend in with the crowd," Journal of Financial Economics, Elsevier, vol. 111(1), pages 137-157.
  • Handle: RePEc:eee:jfinec:v:111:y:2014:i:1:p:137-157
    DOI: 10.1016/j.jfineco.2013.09.002
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    References listed on IDEAS

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    More about this item

    Keywords

    Abandonment; Real options; Signaling; Asymmetric information; Reputation;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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