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Information Aggregation, Investment, and Managerial Incentives

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  • Elias Albagli
  • Christian Hellwig
  • Aleh Tsyvinski

Abstract

We study the interplay of share prices and firm decisions when share prices aggregate and convey noisy information about fundamentals to investors and managers. First, we show that the informational feedback between the firm's share price and its investment decisions leads to a systematic premium in the firm's share price relative to expected dividends. Noisy information aggregation leads to excess price volatility, over-valuation of shares in response to good news, and undervaluation in response to bad news. By optimally increasing its exposure to fundamental risks when the market price conveys good news, the firm shifts its dividend risk to the upside, which amplifies the overvaluation and explains the premium. Second, we argue that explicitly linking managerial compensation to share prices gives managers an incentive to manipulate the firm's decisions to their own benefit. The managers take advantage of shareholders by taking excessive investment risks when the market is optimistic, and investing too little when the market is pessimistic. The amplified upside exposure is rewarded by the market through a higher share price, but is inefficient from the perspective of dividend value.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17330.

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Date of creation: Aug 2011
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Handle: RePEc:nbr:nberwo:17330

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  1. James Dow & Rohit Rahi, 1996. "Informed Trading, Investment and Welfare," Archive Working Papers 029, Birkbeck, Department of Economics, Mathematics & Statistics.
  2. Goldstein, Itay & Ozdenoren, Emre & Yuan, Kathy, 2013. "Trading frenzies and their impact on real investment," Journal of Financial Economics, Elsevier, vol. 109(2), pages 566-582.
  3. George-Marios Angeletos & Guido Lorenzoni & Alessandro Pavan, 2010. "Beauty Contests and "Irrational Exuberance": A Neoclassical Approach," Discussion Papers 1502, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  4. Stein, Jeremy C., 1988. "Takeover Threats and Managerial Myopia," Scholarly Articles 3708937, Harvard University Department of Economics.
  5. Aleh Tsyvinski & Arijit Mukherji & Christian Hellwig, 2006. "Self-Fulfilling Currency Crises: The Role of Interest Rates," American Economic Review, American Economic Association, vol. 96(5), pages 1769-1787, December.
  6. repec:bla:restud:v:75:y:2008:i:1:p:133-164 is not listed on IDEAS
  7. Itay Goldstein & Alexander Guembel, 2008. "Manipulation and the Allocational Role of Prices," Review of Economic Studies, Oxford University Press, vol. 75(1), pages 133-164.
  8. Christopher Polk & Paola Sapienza, 2009. "The Stock Market and Corporate Investment: A Test of Catering Theory," Review of Financial Studies, Society for Financial Studies, vol. 22(1), pages 187-217, January.
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Cited by:
  1. L. Baele & V. De Bruyckere & O. De Jonghe & R. Vander Vennet, 2012. "Do Stock Markets Discipline US Bank Holding Companies: Just Monitoring, or also In?uencing?," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 12/827, Ghent University, Faculty of Economics and Business Administration.
  2. Elias Albagli & Christian Hellwig & Aleh Tsyvinski, 2011. "A Theory of Asset Pricing Based on Heterogeneous Information," NBER Working Papers 17548, National Bureau of Economic Research, Inc.
  3. Christian Hellwig & Aleh Tsyvinski & Elias Albagli, 2012. "A theory of asset prices based on heterogeneous information," 2012 Meeting Papers 394, Society for Economic Dynamics.

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