{"title":"Distortions in Investment Timing and Quantity in Real Options with Asymmetric Information","authors":"Maarten van Oosterhout, Gijsbert Zwart","doi":"10.1007/s10645-023-09428-w","DOIUrl":null,"url":null,"abstract":"Abstract We analyze real options investment under asymmetric information on investment costs, where decisions not only involve investment timing, but also investment quantity. A principal, the regulator, offers a menu of contracts to the agent (the regulated firm). The regulated firm has better information on costs than the regulator, and the optimal regulation trades off distortions in investment decisions and informational rents left to the firm. In a non-dynamic situation, it is well known that optimal contracts involve downward distortions on investment quantity. In the dynamic, real options situation, distortions also occur in investment timing: a high-cost firm’s investment will be delayed beyond the optimal time, until revenues reach a higher investment threshold. We explore the effect on investment quantity in this real option regulation under various assumptions on the stochastic process for revenues. On the one hand, the higher investment threshold tends to increase investment quantities, whereas screening of high-cost firms would favour reducing their investment quantity. We find a simple sufficient condition for the latter, quantity-reducing, effect to dominate, and show that it is satisfied for a wide range of commonly used stochastic processes.","PeriodicalId":46156,"journal":{"name":"Economist-Netherlands","volume":null,"pages":null},"PeriodicalIF":2.4000,"publicationDate":"2023-11-10","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":"0","resultStr":null,"platform":"Semanticscholar","paperid":null,"PeriodicalName":"Economist-Netherlands","FirstCategoryId":"1085","ListUrlMain":"https://doi.org/10.1007/s10645-023-09428-w","RegionNum":4,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":null,"EPubDate":"","PubModel":"","JCR":"Q2","JCRName":"ECONOMICS","Score":null,"Total":0}
引用次数: 0
Abstract
Abstract We analyze real options investment under asymmetric information on investment costs, where decisions not only involve investment timing, but also investment quantity. A principal, the regulator, offers a menu of contracts to the agent (the regulated firm). The regulated firm has better information on costs than the regulator, and the optimal regulation trades off distortions in investment decisions and informational rents left to the firm. In a non-dynamic situation, it is well known that optimal contracts involve downward distortions on investment quantity. In the dynamic, real options situation, distortions also occur in investment timing: a high-cost firm’s investment will be delayed beyond the optimal time, until revenues reach a higher investment threshold. We explore the effect on investment quantity in this real option regulation under various assumptions on the stochastic process for revenues. On the one hand, the higher investment threshold tends to increase investment quantities, whereas screening of high-cost firms would favour reducing their investment quantity. We find a simple sufficient condition for the latter, quantity-reducing, effect to dominate, and show that it is satisfied for a wide range of commonly used stochastic processes.
期刊介绍:
Since 1852, De Economist, the Netherlands Economic Review, has provided an outlet for high quality research in economics. Emphasizing European issues, it offers insightful studies that deal with theoretical issues as well as applied work. The journal also publishes important surveys of current research. Authors of articles based on empirical research are required to make their datasets available to readers, enabling them to replicate the research results.
Officially cited as: De Economist