De Meza, David and Lockwood, Ben (2004) Too much investment: a problem of coordination failure. Working Paper. University of Warwick, Department of Economics, Coventry.

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Abstract

This paper shows that coordination failure and contractual incompleteness can lead to socially excessive investment. Firms and workers choose investment levels then enter a stochastic matching process. If investment levels are discrete, then if match frictions are low enough, high investing workers (firms) impose a negative pecuniary externality on any worker (firm) who cuts investment, even by one unit. Specifically, if a worker cuts investment, he subsequently bargains with a firm which has a high outside option due to the fact it can easily match with another high investing worker; this lowers the private net benefit to cutting investment below the social net benefit. A similar argument establishes that over-investment can occur when agents are heterogenous i.e. differ in their cost of investing, even if investments are continuous. Then, over-investment occurs because low-cost investors have a private incentive to invest to shift rent away from high-cost investors. Our model can also explain some recent trends in graduate/non-graduate wage differentials.

Item Type:	Working or Discussion Paper (Working Paper)
Subjects:	H Social Sciences > HD Industries. Land use. Labor > HD28 Management. Industrial Management Q Science > QA Mathematics
Divisions:	Faculty of Social Sciences > Economics
Library of Congress Subject Headings (LCSH):	Business planning, Investment analysis, Stochastic processes, Matching theory
Series Name:	Warwick economic research papers
Publisher:	University of Warwick, Department of Economics
Place of Publication:	Coventry
Date:	March 2004
Number:	No.703
Number of Pages:	41
Status:	Not Peer Reviewed
Access rights to Published version:	Open Access
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URI:	http://wrap.warwick.ac.uk/id/eprint/1485

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