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Market-Based Solutions to Vital Economic Issues


Kenan Institute 2024 Grand Challenge: Business Resilience
Market-Based Solutions to Vital Economic Issues
Nov 28, 2017

Feedback Effect and Investor Information Acquisition: Implications for Agency Problems


Financial markets reveal information through which firm managers increase the value of equity, e.g., by improving investment decisions. With debt, however, such decisions are not necessarily socially efficient. We demonstrate that investors’ endogenous information acquisition, acting through this feedback channel, attenuates risk-shifting but amplifies debt overhang. The most ex-ante inefficient examples of risk-shifting encourage information acquisition, lowering the likelihood such projects are chosen inefficiently ex-post. The logic reverses with debt overhang: more efficient projects discourage information acquisition, increasing the ex-post likelihood they are foregone. Our model provides a novel channel through which financial markets impact agency frictions between firm stakeholders.

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