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Investments under vertical relations and agency conflicts: a real options approach

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  • Dimitrios Zormpas

Abstract

We examine the case of a firm holding the option to make an uncertain and irreversible investment. The firm is decentralized and there is information asymmetry between the owner and the investment manager regarding the price of an input (e.g. a key equipment) that needs to be purchased by an outside supplier with market power. We show that the total loss attributed to the information asymmetry has two components: i) the loss in the decentralized firm itself and ii) a negative externality that the outside input supplier endures. We show that the latter is likely not just a part, but rather the main component of the total loss. Last, we prove that the negative externality is reduced when the principal uses an audit technology in parallel with the bonus-incentive mechanism.

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  • Dimitrios Zormpas, 2018. "Investments under vertical relations and agency conflicts: a real options approach," 2018 Papers pzo81, Job Market Papers.
    • Handle: RePEc:jmp:jm2018:pzo81
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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General

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