Dynamic reputation, project selection and market efficiency: The importance of small projects

This paper studies the execution of projects under heterogeneous execution abilities and asymmetric information. A higher ability agent, such as a talented entrepreneur, has better execution abilities and this skill advantage is more pronounced for larger and more profitable projects. Reputation, which affects the cost of financing, can be acquired following a successful execution history but may also be inferred when a more talented agent strategically forgoes the execution of certain projects. Our results highlight the role of smaller less-demanding projects in building reputation, revealing ability and increasing profits. These findings carry novel policy implications, as the relative availability of smaller less-demanding projects affects the allocation efficiency of financing and talent and may be required for the subsequent execution of larger more-demanding projects. We show how a change in the availability of such low-NPV projects may generate a significant increase in market efficiency and welfare, an increase that far exceeds their direct-NPV outcome.