Investment dynamics with common and private values

We characterize equilibrium in a dynamic investment game with two-dimensional signals, where each firm observes its idiosyncratic cost of investment and a signal correlated with common investment returns. We demonstrate that the one-step property holds and that investment-cost cutoffs for type-1 firms (with the high common-value signal) and type-0 firms (with the low common-value signal) satisfy a simple equation that does not depend on the cost distribution. However, “reversals” are possible, where a large number of firms investing in a given round becomes bad news about investment returns. The optimal investment subsidy can be either positive or negative. ∗This material is based upon work supported by the NSF under Grant No. SES-0417352. Any opinions, findings and conclusions or recommendations expressed are those of the authors and do not necessarily reflect the views of the NSF. We thank the John Glenn Institute at Ohio State for their support. We are particularly grateful to Asen Ivanov for identifying problems in an earlier draft. This paper has benefitted from comments by seminar participants at ITAM, IUPUI, University of Michigan, The Ohio State University, The Second World Congress in Game Theory (Marseilles, France), Tel Aviv University, Vanderbilt University, and Washington University. Email: [email protected], [email protected].