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The Limitations of Stock Market Efficiency: Price Informativeness and CEO Turnover

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Author Info
Gary B. Gorton
Lixin Huang
Qiang Kang

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Abstract

Stock prices are more informative when the information has less social value. Speculators with limited resources making costly (private) information production decisions must decide to produce information about some firms and not others. We show that producing and trading on private information is most profitable in the stocks of firms with poor corporate governance -- precisely because it will not be acted upon -- and less profitable at firms with better corporate governance. To the extent that the information in the stock price is used for disciplining the CEO by the board of directors, the informed trader has a reduced incentive to produce the information in the first place. We test our model using the probability of informed trading (PIN) and the probability of forced CEO turnover in a simultaneous-equation system. The empirical results support the model predictions. Stock prices are efficient, but there is a limit to the disciplining role they can fulfill. We apply the model to evaluate the effects of the Sarbanes-Oxley Act of 2002.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14944.

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Date of creation: May 2009
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Handle: RePEc:nbr:nberwo:14944

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Find related papers by JEL classification:
G0 - Financial Economics - - General
G1 - Financial Economics - - General Financial Markets
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
G3 - Financial Economics - - Corporate Finance and Governance

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This page was last updated on 2009-11-25.

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