Wait and See, at a Cost

New research shows that investors may lose out on potential returns by waiting too long to capitalize on new opportunities, seeking assurance in others' taking the first risk.
July 22, 2011 | Research Feature
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In the 1970s, Manhattan’s once-vibrant Ladies’ Mile shopping district was suffering from decades of decline. Once-grand stores in the area, which runs from 18th Street up to 24th Street, stretching west to east from 6th Avenue to Park Avenue, had been converted to warehouses or sat semi-deserted, ignored by consumers and investors alike. But by the mid-80s, developers expressed interest in redeveloping the area, and a few years later Bed Bath & Beyond signed on as the first big tenant at a redeveloped 620 Sixth Avenue. Soon after its 1992 opening, others followed, including Barnes and Noble, T.J. Maxx, and Staples.

Professor Boğaçhan Çelen has studied the intersecting dynamics illustrated by the rejuvenation of Ladies’ Mile for some time, examining the role of information and timing and the effects of what economists call complementarities.

“Bed Bath & Beyond assessed the area, gathered information about it, and decided that it could easily become profitable again,” Çelen says. “Other retailers probably had an idea of the area’s potential, but seeing one big player take the risk gave confidence to others, who waited to learn” — to gain information, that is — “about whether Bed Bath & Beyond’s risk would pay off before following suit.”

The presence of a major retailer also meant that any new retailers setting up shop would be likely to benefit from complementarity effects, in which the presence of many businesses or investors enhance one another. In this case, consumers shopping at Bed Bath & Beyond can go on to shop at a number of different stores within the same few blocks, so all stores in the area benefit from their proximity to each other.

These dynamics play out in many investment scenarios. For example, a firm weighing foreign direct investment (FDI) in a developing country usually faces limited information and varying degrees of certainty about that country’s political stability, local business climate, and so on. Even if a firm’s own information suggests a favorable return is likely, unless the firm is willing to take the risk itself, it must wait and seek assurance from another firm’s entrance into the market. Once one firm takes the plunge, its presence encourages others to follow suit, and complementarities arise and profits flow.

Two distinct strands of research investigate timing and complementarity separately, but the two work in tandem. By investigating both together, Çelen hoped to learn more about how people make investment choices when both these factors are at play. If there is a waiting period that people can use strategically to acquire telling information from others’ decisions, do they capitalize on it? How long do they wait to invest?

Working with Francesco Brindisi of the New York City Economic Development Corporation and Columbia University’s School of International and Public Affairs and with Kyle Hyndman of Southern Methodist University, Çelen ran an experiment that mimicked the way FDI works.

In one of two variations, pairs of subjects had to decide at the same time whether or not to invest their money without any opportunity to gain information from watching or waiting to see what the person they were paired with would do. Each subject was given private information about the profitability of the investment. The second variation gave the subjects the opportunity to invest immediately or to wait so they could see whether or not others would invest before they made their decision. Waiting to invest incurred a cost, giving subjects an incentive to act early.

“When two people received the same kind and magnitude of information, they tended to invest when they were forced to make the decision immediately or in the very near term,” Çelen says. “Whereas when given time to wait, they did. That implies both that people want to be very confident and that they are willing to pay the cost of waiting to see what others do.” The researchers also found that a substantial proportion of subjects — between 30 and 40 percent — waited quite a bit longer to invest than the researchers’ theoretical model predicted.

“Even though they knew the information they had was good — that the investment was likely to be a good one — they were much more confidence-seeking than we thought they would be,” Çelen says. “People seem to want a lot of assurance.”

Of course, the problem with waiting is that it can delay the emergence of the complementarities that benefit so many market participants. If, as this research suggests, people are prone to delay when they face a relatively safe investment opportunity, what to do?

One implication is that the biggest players — who are typically able to tolerate greater risks — should be encouraged to lead the way, Çelen says. While TARP and the federal government’s first stimulus plan were controversial, shoring up larger companies and banks may have kept existing complementarities in play while encouraging new ones, at the same time providing important cues for smaller firms and the public. Similarly, developers and brokers may want to try to sweetening deals for large, early investors in an effort to set off the desired domino effect. “If confidence-seeking behavior is so important to people, encouraging larger firms to invest may provide assurance to smaller players,” Çelen says. “With confidence boosted, others would start investing too, complementarities would take hold, and everyone would reap benefits.”

Boğaçhan Çelen is associate professor of finance and economics at Columbia Business School.

Bogachan Celen

Bogachan Celen was a Columbia Business School faculty member from 2004 to 2014.