Decentralized Information Acquistion and the Internal Provision of Capital

Abstract

This paper investigates a model where a decentralized manager gathers private information about the profitability of an investment project that must be financed internally. The choice of information acquisition effort depends on a tradeoff between her expected marginal information rent and the associated private effort cost. Expected information rents are higher if asymmetric information arises endogenously rather than being exogenous. Therefore, the manager puts in too much information-gathering effort and headquarters reacts with a sharp rationing of capital. Monitoring the manager's information acquisition mitigates underinvestment but even increases the manager's information gathering activity. Finally, efficiency unambiguously rises if headquarters can commit to an investment budget before the manager gathers the information.