Information Aggregation, Investment, and Managerial Incentives
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.
|Date of creation:||Aug 2011|
|Date of revision:|
|Note:||AP CF EFG|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
Web page: http://www.nber.org
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- 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.
- Goldstein, Itay & Ozdenoren, Emre & Yuan, Kathy, 2010. "Trading Frenzies and Their Impact on Real Investment," CEPR Discussion Papers 7652, C.E.P.R. Discussion Papers.
- Kathy Yuan & Emre Ozdenoren & Itay Goldstein, 2010. "Trading Frenzies and Their Impact on Real Investment," 2010 Meeting Papers 94, Society for Economic Dynamics.
- Itay Goldstein & Emre Ozdenoren & Kathy Yuan, 2011. "Trading Frenzies and their Impact on Real Investment," FMG Discussion Papers dp670, Financial Markets Group.
- James Dow, 2003.
"Informed Trading, Investment, and Welfare,"
The Journal of Business,
University of Chicago Press, vol. 76(3), pages 439-454, July.
- James Dow & Rohit Rahi, 1996. "Informed Trading, Investment and Welfare," Archive Working Papers 029, Birkbeck, Department of Economics, Mathematics & Statistics.
- Dow, J & Rahi, R, 1997. "Informed Trading, Investment, and Welfare," Economics Working Papers eco97/03, European University Institute.
- Rohit Rahi & James Dow, 1998. "Informed Trading, Investment, and Welfare," FMG Discussion Papers dp292, Financial Markets Group.
- 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.
- Easley, David, et al, 1996. " Liquidity, Information, and Infrequently Traded Stocks," Journal of Finance, American Finance Association, vol. 51(4), pages 1405-36, September.
- George-Marios Angeletos & Guido Lorenzoni & Alessandro Pavan, 2010.
"Beauty Contests and Irrational Exuberance: A Neoclassical Approach,"
NBER Working Papers
15883, National Bureau of Economic Research, Inc.
- 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.
- George-Marios Angeletos & Guido Lorenzoni & Alessandro Pavan, 2010. "Beauty Contests and Irrational Exuberance: A Neoclassical Approach," Levine's Working Paper Archive 661465000000000237, David K. Levine.
- 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.
- Stein, Jeremy C, 1988.
"Takeover Threats and Managerial Myopia,"
Journal of Political Economy,
University of Chicago Press, vol. 96(1), pages 61-80, February.
- Christian Hellwig & Arijit Mukherji & Aleh Tsyvinski, 2005.
"Self-Fulfilling Currency Crises: The Role of Interest Rates,"
NBER Working Papers
11191, National Bureau of Economic Research, Inc.
- 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.
When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:17330. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.