Finance Cluster Seminar: Ambiguity and the Corporation: Group Decisions, Time Inconsistency, and Underinvestment
Corporate decisions undertaken by groups of agents with heterogeneous beliefs, such as a corporate board, are de facto "ambiguous" to the group, even if each group member is Bayesian. In such cases, governance mechanisms must aggregate diverse priors to reach a decision. We show that Utilitarian, "Rawlsian," and Inertia-based governance rules are dynamically inconsistent. This inconsistency may lead to underinvestment; that is, multi-stage projects that would be undertaken by each group member are rejected by the group because of anticipated future disagreement. The issuance of securities such as risky and convertible bonds can generate unanimity and eliminate underinvestment.