RWP 25-11, September 2025
How do information frictions and investment frictions interact? We use a continuous-time model to analytically characterize how incomplete information distorts firms’ decision rules and stationary distribution when investment is irreversible. The two frictions interact in rich and substantial ways. At the firm level, noisier information shrinks a firm’s inaction region and reduces the elasticity of investment to productivity. In the aggregate, incomplete information increases steady-state capital, exacerbates capital misallocation, and mitigates the impact of productivity shocks on aggregate investment. We test and quantify these predictions using Japanese administrative data that match firms’ forecasts with their balance sheets, incomes, and expenditures. In the data, firms underreact to news as if they face information frictions; those with more extreme underreaction are less inactive, as predicted.
JEL classifications: D25, D84, E22, E32
Article Citation
Adams, Jonathan J., Cheng Chen, Min Fang, Takahiro Hattori, and Eugenio Rojas. 2025. “Incomplete Information and Irreversible Investment.” Federal Reserve Bank of Kansas City, Research Working Paper no. 25-11, September. Available at External Linkhttps://doi.org/10.18651/RWP2025-11
The views expressed are those of the authors and do not necessarily reflect the positions of the Federal Reserve Bank of Kansas City or the Federal Reserve System.