Incentives for Information Production in Markets where Prices Affect Real Investment1

A fundamental role of financial markets is to gather information on firms’ investment opportunities, and so help guide investment decisions. In this paper we study the incentives for information production when prices perform this allocational role. If firms cancel planned investments following poor stock market response, the value of their shares will become insensitive to information on investment opportunities, so that speculators will be deterred from producing information ex ante. Based on this insight, we derive the following main results. (1) Strategic complementarities in information production may arise, leading to multiple equilibria with different levels of information. (2) The incentive to produce information decreases when economic fundamentals deteriorate, leading to an amplification of shocks to fundamentals. (3) Incentives to produce information on assets in place are stronger than for new investment opportunities. (4) Firms will attract more information production and improve their ex-ante value by committing to overinvest.