Financing a Black Box: Dynamic Investment with Persistent Private Information

45 Pages Posted: 29 Jun 2020 Last revised: 6 Apr 2022

See all articles by Felix Zhiyu Feng

Felix Zhiyu Feng

University of Washington - Michael G. Foster School of Business

Date Written: April 1, 2022

Abstract

This paper studies the implication of persistent private information on firms’ optimal financing and investment policies. In a dynamic agency model, an investor supplies capital to an entrepreneur with an opaque production technology. The entrepreneur can generate private benefit from manipulating and misreporting his productivity with a persistent negative effect on future productivity growth. Compared to standard agency-based investment models, the persistency of agency frictions rationalizes over-investment especially among firms with strong histories of cash flows but low Tobin's q, and reconciles the optimal financing policy with the empirical observations of a strong investment-cash-flow sensitivity and a weak investment-q sensitivity.

Keywords: dynamic agency, persistent private information, investment, entrepreneurship, q-theory

JEL Classification: G32, D86, D25, L26

Suggested Citation

Feng, Felix, Financing a Black Box: Dynamic Investment with Persistent Private Information (April 1, 2022). Available at SSRN: https://ssrn.com/abstract=3626839 or http://dx.doi.org/10.2139/ssrn.3626839

Felix Feng (Contact Author)

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States

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