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Ambiguity and the corporation: Group disagreement and underinvestment

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  • Garlappi, Lorenzo
  • Giammarino, Ron
  • Lazrak, Ali

Abstract

We study a dynamic corporate investment problem where decisions have to be made collectively by a group of agents holding heterogeneous beliefs and adhering to a “utilitarian” governance mechanism in which each agent has a given influence in the decision. In this setting we show that: (i) group decisions are typically dynamically inconsistent, (ii) dynamic inconsistency leads to inefficient underinvestment, and (iii) the ability to trade securities among insiders or with outsiders may restore efficient investment decisions but it may, in some cases, lead to inefficient overinvestment. Our theory can help explain the empirical evidence on the effect of diversity of groups, such as corporate boards, on firms’ outcomes and, more generally, on the difference between group and individual behavior.

Suggested Citation

  • Garlappi, Lorenzo & Giammarino, Ron & Lazrak, Ali, 2017. "Ambiguity and the corporation: Group disagreement and underinvestment," Journal of Financial Economics, Elsevier, vol. 125(3), pages 417-433.
  • Handle: RePEc:eee:jfinec:v:125:y:2017:i:3:p:417-433
    DOI: 10.1016/j.jfineco.2017.06.005
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    Cited by:

    1. Donaldson, Jason Roderick & Malenko, Nadya & Piacentino, Giorgia, 2017. "Deadlock on the Board," CEPR Discussion Papers 12503, C.E.P.R. Discussion Papers.
    2. repec:eee:jfinec:v:130:y:2018:i:3:p:641-662 is not listed on IDEAS
    3. Swagata Bhattacharjee, 2019. "Dynamic Contracting for Innovation Under Ambiguity," Working Papers 1022, Ashoka University, Department of Economics, revised Aug 2019.

    More about this item

    Keywords

    Ambiguity; Group decisions; Dynamic consistency; Dynamic real investment; Security issuance;

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • D25 - Microeconomics - - Production and Organizations - - - Intertemporal Firm Choice: Investment, Capacity, and Financing
    • D70 - Microeconomics - - Analysis of Collective Decision-Making - - - General

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