Author Abstract
We investigate a puzzling phenomenon in which firms make investment decisions that purposefully do not maximize expected profits. Using an extension to the newsvendor model, we focus on a relatively common scenario in which the firm's investor has imperfect information concerning the quality of the firm's investment opportunities. We apply Perfect Bayesian equilibrium solution concepts and confirm that over a range of reasonable model parameters the firm's investment decision does not maximize expected profits. Surprisingly, this includes instances in which a firm with a higher quality investment opportunity finds it attractive to underinvest, thereby behaving as if the investor faces a lower quality investment opportunity. This is particularly interesting, as prior research in finance literature has shown that firms will overinvest in high quality projects when investors have imperfect information about the quality of the firm's opportunities. While we conduct our analysis in the context of an inventory stocking decision, our model is generalizable to other types of capacity investment decisions.
Paper Information
- Full Working Paper Text
- Working Paper Publication Date: April 2011 (Revised February 2012)
- HBS Working Paper Number: 11-105
- Faculty Unit(s): Technology and Operations Management