We study an informational role of investment when a bankruptcy market suffers from information asymmetry. In our model, equityholders of a levered firm forgo positive-NPV projects when the firm’s asset quality is low. But due to this underinvestment, ill-informed potential asset buyers can distinguish between good firms and bad firms from their past investment decisions. Put differently, the agency friction between equity and debt can alleviate the information friction in the bankruptcy market. Therefore, policies seeking to stimulate investment during recessions may reduce the informational contents of investment, leading to the lower recovery value for assets in default. We provide some suggestive empirical evidence that supports our model. 

Keywords: Debt overhang, information asymmetry, informative underinvestment, bankruptcy costs.​