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Investment Busts, Reputation, and the Temptation to Blend in with the Crowd

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  • Steven Grenadier
  • Andrey Malenko
  • Ilya A. Strebulaev

Abstract

We provide a dynamic model of an industry in which agents strategically time liquidation decisions in an effort to protect their reputations. As in traditional models, agents delay liquidation attempting to signal their quality. However, when the industry faces a common shock that indiscriminately forces liquidation of a subset of projects, agents with bad enough projects choose to liquidate even if their projects are unaffected by the shock. Such "blending in with the crowd" creates an additional incentive to delay liquidation, further amplifying the shock. As a result, even minuscule common shocks can be evidenced by massive liquidations. As agents await common shocks, the industry accumulates "living dead" projects. Surprisingly, the potential for moderate negative common shocks often improves agents values.

Suggested Citation

  • Steven Grenadier & Andrey Malenko & Ilya A. Strebulaev, 2012. "Investment Busts, Reputation, and the Temptation to Blend in with the Crowd," NBER Working Papers 17945, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:17945
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    1. Alex Edmans & William Mann, 2019. "Financing Through Asset Sales," Management Science, INFORMS, vol. 65(7), pages 3043-3060, July.

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    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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