Information Aggregation, Investment, and Managerial Incentives
AbstractWe 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 InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17330.
Date of creation: Aug 2011
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Other versions of this item:
- Elias Albagli & Christian Hellwig & Aleh Tsyvinski, 2011. "Information Aggregation, Investment, and Managerial Incentives," Levine's Working Paper Archive 786969000000000197, David K. Levine.
- Albagli, Elias & Hellwig, Christian & Tsyvinski, Aleh, 2011. "Information Aggregation, Investment, and Managerial Incentives," CEPR Discussion Papers 8539, C.E.P.R. Discussion Papers.
- Elias Albagli & Christian Hellwig & Aleh Tsyvinski, 2011. "Information Aggregation, Investment, and Managerial Incentives," Cowles Foundation Discussion Papers 1816, Cowles Foundation for Research in Economics, Yale University.
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G30 - Financial Economics - - Corporate Finance and Governance - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-08-29 (All new papers)
- NEP-BEC-2011-08-29 (Business Economics)
- NEP-CTA-2011-08-29 (Contract Theory & Applications)
- NEP-HRM-2011-08-29 (Human Capital & Human Resource Management)
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