Making Bad Decisions: firm size and investment under uncertainty

Abstract

This paper presents a 'real options' model of investment under uncertainty, which incorporates the assumption of a financial market characterised by asymmetric information and which can explain the stylised facts of firm growth. The decision-making situation faced by small and medium-sized enterprises (SMEs) features much greater constraints on the ability to gather information in order to reduce uncertainty about their investment opportunities, compared with that faced by large companies (LCs). This necessarily causes relatively poor decision-making by SMEs, and explains their substantial death rates.