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

Listed author(s):
  • Thomas H. Noe
  • Michael J. Rebello
  • Thomas A. Rietz

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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File URL: http://www.finance.ox.ac.uk/file_links/finecon_papers/2008fe12.pdf
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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
Handle: RePEc:sbs:wpsefe:2008fe12
Contact details of provider: Web page: http://www.finance.ox.ac.uk
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  7. Forsythe, Robert & Lundholm, Russell & Rietz, Thomas, 1999. "Cheap Talk, Fraud, and Adverse Selection in Financial Markets: Some Experimental Evidence," Review of Financial Studies, Society for Financial Studies, vol. 12(3), pages 481-518.
  8. Gaspar, Jose-Miguel & Massa, Massimo & Matos, Pedro, 2005. "Shareholder investment horizons and the market for corporate control," Journal of Financial Economics, Elsevier, vol. 76(1), pages 135-165, April.
  9. Flannery, Mark J, 1986. " Asymmetric Information and Risky Debt Maturity Choice," Journal of Finance, American Finance Association, vol. 41(1), pages 19-37, March.
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  16. Camerer, Colin & Weigelt, Keith, 1988. "Experimental Tests of a Sequential Equilibrium Reputation Model," Econometrica, Econometric Society, vol. 56(1), pages 1-36, January.
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  18. Narayanan, M. P., 1996. "Form of Compensation and Managerial Decision Horizon," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(04), pages 467-491, December.
  19. Noe, Thomas H & Rebello, Michael J, 1996. " Asymmetric Information, Managerial Opportunism, Financing, and Payout Policies," Journal of Finance, American Finance Association, vol. 51(2), pages 637-660, June.
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  22. Cadsby, Charles Bram & Frank, Murray & Maksimovic, Vojislav, 1998. "Equilibrium Dominance in Experimental Financial Markets," Review of Financial Studies, Society for Financial Studies, vol. 11(1), pages 189-232.
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  24. Cadsby, Charles B & Frank, Murray & Maksimovic, Vojislav, 1990. "Pooling, Separating, and Semiseparating Equilibria in Financial Markets: Some Experimental Evidence," Review of Financial Studies, Society for Financial Studies, vol. 3(3), pages 315-342.
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