Asymmetric information, option to wait to invest and the optimal level of investment

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Abstract

This paper analyzes equilibrium rationing on credit markets in the case of gains from waiting to acquire information about the future profitability of investment. We compare the competitive outcome with the socially optimal level of investment. We show that the opportunity to postpone investment changes the nature of the inefficiencies of the competitive outcome fundamentally. Without the option to wait, high risk firms tend to invest and the outcome is characterized by a situation of underinvestment. If firms can wait high risk firms benefit the most from waiting. In this case low risk firms tend to invest immediately and a situation of overinvestment will result, since from the banks' point of view firms do not delay enough. (C) 2001 Elsevier Science B.V. All rights reserved.

Original languageEnglish
Pages (from-to)365-374
Number of pages10
JournalJournal of Public Economics
Volume79
Issue number2
DOIs
Publication statusPublished - Feb-2001

Keywords

  • irreversible investment
  • asymmetric information
  • CREDIT
  • MARKET
  • COSTS

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