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

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

Journal of Financial Economics. January
2014, Vol. 111, Issue 1, Pages 137-157

We provide a real-options model of an industry in which agents time abandonment of their projects in an effort to protect their reputations. Agents delay abandonment attempting to signal quality. When a public common shock forces abandonment of a small fraction of projects irrespective of agents’ quality, many agents abandon their projects strategically even if they are unaffected by the shock. Such “blending in with the crowd” effect creates an additional incentive to delay abandonment ahead of the shock, leading to accumulation of “living dead” projects, which further amplifies the shock. The potential for moderate public common shocks often improves agents’ values.