IDEAS home Printed from https://ideas.repec.org/a/oup/revfin/v21y2017i1p153-200..html
   My bibliography  Save this article

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

Author

Listed:
  • Gary B. Gorton
  • Lixin Huang
  • Qiang Kang

Abstract

There is a tenuous link between market efficiency and economic efficiency in that stock prices are more informative when the information has less social value. We investigate this link in the context of CEO turnover. Our theoretical model predicts that, when the board’s monitoring intensity and the informed trader’s information decision are jointly endogenized, stock price informativeness is negatively related to the board’s monitoring effort. Our empirical tests provide supporting evidence for this negative effect. Moreover, using the passage of the Sarbanes–Oxley Act (SOX) as a quasi-natural experiment, we find that SOX, while strengthening corporate governance, has a negative effect on stock price informativeness, especially among firms with complex organizational structures.

Suggested Citation

  • Gary B. Gorton & Lixin Huang & Qiang Kang, 2017. "The Limitations of Stock Market Efficiency: Price Informativeness and CEO Turnover," Review of Finance, European Finance Association, vol. 21(1), pages 153-200.
    • Handle: RePEc:oup:revfin:v:21:y:2017:i:1:p:153-200.
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1093/rof/rfw008
    Download Restriction: Access to full text is restricted to subscribers.
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Barro, Jason R & Barro, Robert J, 1990. "Pay, Performance, and Turnover of Bank CEOs," Journal of Labor Economics, University of Chicago Press, vol. 8(4), pages 448-481, October.
    2. Malcolm Baker & Jeremy C. Stein & Jeffrey Wurgler, 2003. "When Does the Market Matter? Stock Prices and the Investment of Equity-Dependent Firms," The Quarterly Journal of Economics, Oxford University Press, vol. 118(3), pages 969-1005.
    3. Dow, James & Gorton, Gary, 1997. "Stock Market Efficiency and Economic Efficiency: Is There a Connection?," Journal of Finance, American Finance Association, vol. 52(3), pages 1087-1129, July.
    4. David Easley & Soeren Hvidkjaer & Maureen O'Hara, 2002. "Is Information Risk a Determinant of Asset Returns?," Journal of Finance, American Finance Association, vol. 57(5), pages 2185-2221, October.
    5. Lixiong Guo & Ronald W. Masulis, 2015. "Board Structure and Monitoring: New Evidence from CEO Turnovers," Review of Financial Studies, Society for Financial Studies, vol. 28(10), pages 2770-2811.
    6. Ryan, Harley Jr. & Wiggins, Roy III, 2004. "Who is in whose pocket? Director compensation, board independence, and barriers to effective monitoring," Journal of Financial Economics, Elsevier, vol. 73(3), pages 497-524, September.
    7. Brown, Stephen & Hillegeist, Stephen A. & Lo, Kin, 2004. "Conference calls and information asymmetry," Journal of Accounting and Economics, Elsevier, vol. 37(3), pages 343-366, September.
    8. Dirk Jenter & Fadi Kanaan, 2015. "CEO Turnover and Relative Performance Evaluation," Journal of Finance, American Finance Association, vol. 70(5), pages 2155-2184, October.
    9. Heckman, James J, 1978. "Dummy Endogenous Variables in a Simultaneous Equation System," Econometrica, Econometric Society, vol. 46(4), pages 931-959, July.
    10. Alex Edmans & Itay Goldstein & Wei Jiang, 2011. "Feedback Effects and the Limits to Arbitrage," NBER Working Papers 17582, National Bureau of Economic Research, Inc.
    11. Fich, Eliezer M. & Shivdasani, Anil, 2007. "Financial fraud, director reputation, and shareholder wealth," Journal of Financial Economics, Elsevier, vol. 86(2), pages 306-336, November.
    12. Mark R. Huson & Robert Parrino & Laura T. Starks, 2001. "Internal Monitoring Mechanisms and CEO Turnover: A Long‐Term Perspective," Journal of Finance, American Finance Association, vol. 56(6), pages 2265-2297, December.
    13. Renée B. Adams & Daniel Ferreira, 2007. "A Theory of Friendly Boards," Journal of Finance, American Finance Association, vol. 62(1), pages 217-250, February.
    14. Gilson, Stuart C., 1990. "Bankruptcy, boards, banks, and blockholders : Evidence on changes in corporate ownership and control when firms default," Journal of Financial Economics, Elsevier, vol. 27(2), pages 355-387, October.
    15. James Dow, 2003. "Informed Trading, Investment, and Welfare," The Journal of Business, University of Chicago Press, vol. 76(3), pages 439-454, July.
    16. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    17. Yermack, David, 1996. "Higher market valuation of companies with a small board of directors," Journal of Financial Economics, Elsevier, vol. 40(2), pages 185-211, February.
    18. Qi Chen & Itay Goldstein & Wei Jiang, 2007. "Price Informativeness and Investment Sensitivity to Stock Price," Review of Financial Studies, Society for Financial Studies, vol. 20(3), pages 619-650.
    19. Hermalin, Benjamin E & Weisbach, Michael S, 1998. "Endogenously Chosen Boards of Directors and Their Monitoring of the CEO," American Economic Review, American Economic Association, vol. 88(1), pages 96-118, March.
    20. Robert Gibbons & Kevin J. Murphy, 1990. "Relative Performance Evaluation for Chief Executive Officers," ILR Review, Cornell University, ILR School, vol. 43(3), pages 30, April.
    21. Gibbons, Robert & Murphy, Kevin J, 1992. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 468-505, June.
    22. Eliezer M. Fich, 2005. "Are Some Outside Directors Better than Others? Evidence from Director Appointments by Fortune 1000 Firms," The Journal of Business, University of Chicago Press, vol. 78(5), pages 1943-1972, September.
    23. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
    24. John C. Coates IV, 2007. "The Goals and Promise of the Sarbanes-Oxley Act," Journal of Economic Perspectives, American Economic Association, vol. 21(1), pages 91-116, Winter.
    25. Khanna, Naveen & Slezak, Steve L & Bradley, Michael, 1994. "Insider Trading, Outside Search, and Resource Allocation: Why Firms and Society May Disagree on Insider Trading Restrictions," Review of Financial Studies, Society for Financial Studies, vol. 7(3), pages 575-608.
    26. James Dow & Gary Gorton & Arvind Krishnamurthy, 2005. "Equilibrium Investment and Asset Prices under Imperfect Corporate Control," American Economic Review, American Economic Association, vol. 95(3), pages 659-681, June.
    27. Rivers, Douglas & Vuong, Quang H., 1988. "Limited information estimators and exogeneity tests for simultaneous probit models," Journal of Econometrics, Elsevier, vol. 39(3), pages 347-366, November.
    28. Easley, David & Kiefer, Nicholas M & O'Hara, Maureen, 1996. "Cream-Skimming or Profit-Sharing? The Curious Role of Purchased Order Flow," Journal of Finance, American Finance Association, vol. 51(3), pages 811-833, July.
    29. William N. Evans & Wallace E. Oates & Robert M. Schwab & William N. Evans & Wallace E. Oates & Robert M. Schwab, 2004. "Measuring Peer Group Effects: A Study of Teenage Behavior," Chapters, in: Environmental Policy and Fiscal Federalism, chapter 13, pages 232-257, Edward Elgar Publishing.
    30. Steven N. Kaplan & Bernadette Minton, 2006. "How has CEO Turnover Changed? Increasingly Performance Sensitive Boards and Increasingly Uneasy CEOs," NBER Working Papers 12465, National Bureau of Economic Research, Inc.
    31. Avanidhar Subrahmanyam & Sheridan Titman, 1999. "The Going‐Public Decision and the Development of Financial Markets," Journal of Finance, American Finance Association, vol. 54(3), pages 1045-1082, June.
    32. Haidan Li & Morton Pincus & Sonja Olhoft Rego, 2008. "Market Reaction to Events Surrounding the Sarbanes-Oxley Act of 2002 and Earnings Management," Journal of Law and Economics, University of Chicago Press, vol. 51(1), pages 111-134, February.
    33. Holmstrom, Bengt & Tirole, Jean, 1993. "Market Liquidity and Performance Monitoring," Journal of Political Economy, University of Chicago Press, vol. 101(4), pages 678-709, August.
    34. Leland, Hayne E, 1992. "Insider Trading: Should It Be Prohibited?," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 859-887, August.
    35. Ernst Maug, 1998. "Large Shareholders as Monitors: Is There a Trade-Off between Liquidity and Control?," Journal of Finance, American Finance Association, vol. 53(1), pages 65-98, February.
    36. Ronald A. Dye & S. Sridhar, 2002. "Resource Allocation Effects of Price Reactions to Disclosures," Contemporary Accounting Research, John Wiley & Sons, vol. 19(3), pages 385-410, September.
    37. Yuanzhi Luo, 2005. "Do Insiders Learn from Outsiders? Evidence from Mergers and Acquisitions," Journal of Finance, American Finance Association, vol. 60(4), pages 1951-1982, August.
    38. Benjamin E. Hermalin, 2005. "Trends in Corporate Governance," Journal of Finance, American Finance Association, vol. 60(5), pages 2351-2384, October.
    39. Benjamin E. Hermalin & Michael S. Weisbach, 2003. "Boards of directors as an endogenously determined institution: a survey of the economic literature," Economic Policy Review, Federal Reserve Bank of New York, vol. 9(Apr), pages 7-26.
    40. Amemiya, Takeshi, 1979. "The Estimation of a Simultaneous-Equation Tobit Model," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 20(1), pages 169-181, February.
    41. Michael J. Fishman & Kathleen M. Hagerty, 1992. "Insider Trading and the Efficiency of Stock Prices," RAND Journal of Economics, The RAND Corporation, vol. 23(1), pages 106-122, Spring.
    42. Marianne Bertrand & Sendhil Mullainathan, 2001. "Are CEOs Rewarded for Luck? The Ones Without Principals Are," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 116(3), pages 901-932.
    43. Roberta Romano, 2004. "The Sarbanes-Oxley Act and the Making of Quack Corporate Governance," Yale School of Management Working Papers amz2653, Yale School of Management, revised 01 Jul 2005.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Bennett, Benjamin & Stulz, René & Wang, Zexi, 2020. "Does the stock market make firms more productive?," Journal of Financial Economics, Elsevier, vol. 136(2), pages 281-306.
    2. Hazarika, Sonali & Karpoff, Jonathan M. & Nahata, Rajarishi, 2012. "Internal corporate governance, CEO turnover, and earnings management," Journal of Financial Economics, Elsevier, vol. 104(1), pages 44-69.
    3. Nguyen, Canh Phuc & Nguyen, Thai Vu Hong & Schinckus, Christophe, 2019. "Institutions, economic openness and stock return co-movements: An empirical investigation in emerging markets," Finance Research Letters, Elsevier, vol. 28(C), pages 137-147.
    4. Antoinette Schoar & Ebonya L. Washington, 2011. "Are the Seeds of Bad Governance Sown in Good Times?," NBER Working Papers 17061, National Bureau of Economic Research, Inc.
    5. Ramzi Benkraiem & Sabri Boubaker & Asif Saeed, 2022. "How does corporate social responsibility engagement affect the information content of stock prices?," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 43(5), pages 1266-1289, July.
    6. Zhang, Qiyu & Zhang, Xiaoxiang & Chen, Ding & Strange, Roger, 2022. "Market discipline or rent extraction: Impacts of share trading by foreign institutional investors in different corporate governance and investor protection environments," International Review of Financial Analysis, Elsevier, vol. 79(C).
    7. Wang, Xiaoqiong & Zhen, Hongxian & Zhu, Feifei, 2023. "Voting with their feet: Controlling shareholders' share pledging and other major shareholders' strategic response," Pacific-Basin Finance Journal, Elsevier, vol. 79(C).
    8. Michael Anthony Adams, 2020. "Fiscal Policy and Stock Market Efficiency in the USA: An ARDL Bounds Testing Approach," Journal of Accounting, Business and Finance Research, Scientific Publishing Institute, vol. 9(2), pages 73-81.
    9. Ni, Yensen & Huang, Paoyu & Chen, Yuhsin, 2019. "Board structure, considerable capital, and stock price overreaction informativeness in terms of technical indicators," The North American Journal of Economics and Finance, Elsevier, vol. 48(C), pages 514-528.
    10. Mona A. ElBannan & Omar Farooq, 2019. "When are earnings informative?," International Journal of Islamic and Middle Eastern Finance and Management, Emerald Group Publishing Limited, vol. 12(3), pages 388-406, June.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Renee B. Adams & Benjamin E. Hermalin & Michael S. Weisbach, 2010. "The Role of Boards of Directors in Corporate Governance: A Conceptual Framework and Survey," Journal of Economic Literature, American Economic Association, vol. 48(1), pages 58-107, March.
    2. James Dow & Itay Goldstein & Alexander Guembel, 2017. "Incentives for Information Production in Markets where Prices Affect Real Investment," Journal of the European Economic Association, European Economic Association, vol. 15(4), pages 877-909.
    3. Nanda, Vikram & Onal, Bunyamin, 2016. "Incentive contracting when boards have related industry expertise," Journal of Corporate Finance, Elsevier, vol. 41(C), pages 1-22.
    4. Dirk Jenter & Fadi Kanaan, 2015. "CEO Turnover and Relative Performance Evaluation," Journal of Finance, American Finance Association, vol. 70(5), pages 2155-2184, October.
    5. Hamdi Ben-Nasr & Abdullah Alshwer, 2015. "How Informed Stock Trading Can Affect Labor Investment Efficiency," Proceedings of Business and Management Conferences 2304077, International Institute of Social and Economic Sciences.
    6. Ben-Nasr, Hamdi & Alshwer, Abdullah A., 2016. "Does stock price informativeness affect labor investment efficiency?," Journal of Corporate Finance, Elsevier, vol. 38(C), pages 249-271.
    7. Tse-Chun Lin & Qi Liu & Bo Sun, 2015. "Contracting with Feedback," International Finance Discussion Papers 1143, Board of Governors of the Federal Reserve System (U.S.).
    8. Fujun Lai & Qian Wang & Qingxiang Feng, 2019. "Does Chinese Financial Market Information Promote Listed Manufacturing Firms’ Productivity?," Sustainability, MDPI, vol. 11(2), pages 1-20, January.
    9. 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.
    10. Bai, Jennie & Philippon, Thomas & Savov, Alexi, 2016. "Have financial markets become more informative?," Journal of Financial Economics, Elsevier, vol. 122(3), pages 625-654.
    11. Dow, James, 2013. "Boards, CEO entrenchment, and the cost of capital," Journal of Financial Economics, Elsevier, vol. 110(3), pages 680-695.
    12. Bade, Marco & Hirth, Hans, 2016. "Liquidity cost vs. real investment efficiency," Journal of Financial Markets, Elsevier, vol. 28(C), pages 70-90.
    13. Benhabib, Jess & Liu, Xuewen & Wang, Pengfei, 2016. "Sentiments, financial markets, and macroeconomic fluctuations," Journal of Financial Economics, Elsevier, vol. 120(2), pages 420-443.
    14. Kathy Yuan & Emre Ozdenoren & Itay Goldstein, 2008. "Learning and Complementarities: Implications for Speculative Attacks," 2008 Meeting Papers 276, Society for Economic Dynamics.
    15. Ferreira, Daniel & Ferreira, Miguel A. & Raposo, Clara C., 2011. "Board structure and price informativeness," Journal of Financial Economics, Elsevier, vol. 99(3), pages 523-545, March.
    16. Carola Frydman & Dirk Jenter, 2010. "CEO Compensation," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 75-102, December.
    17. Alex Edmans & Itay Goldstein & Wei Jiang, 2012. "The Real Effects of Financial Markets: The Impact of Prices on Takeovers," Journal of Finance, American Finance Association, vol. 67(3), pages 933-971, June.
    18. Dirk Jenter & Katharina Lewellen, 2021. "Performance-Induced CEO Turnover [The “Wall Street Walk” and shareholder activism: Exit as a form of voice]," The Review of Financial Studies, Society for Financial Studies, vol. 34(2), pages 569-617.
    19. Bennett, Benjamin & Stulz, René & Wang, Zexi, 2020. "Does the stock market make firms more productive?," Journal of Financial Economics, Elsevier, vol. 136(2), pages 281-306.
    20. Itay Goldstein, 2023. "Information in Financial Markets and Its Real Effects," Review of Finance, European Finance Association, vol. 27(1), pages 1-32.

    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:oup:revfin:v:21:y:2017:i:1:p:153-200.. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Oxford University Press (email available below). General contact details of provider: https://edirc.repec.org/data/eufaaea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.