Strategic Information Revelation and Capital Allocation
It is commonly believed that stock prices help firms' managers make more efficient real investment decisions, because they aggregate information about fundamentals that is not otherwise known to managers. This paper identifies a limitation to...
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| Format: | Policy Research Working Paper |
| Language: | English en_US |
| Published: |
World Bank Group, Washington, DC
2014
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| Online Access: | http://documents.worldbank.org/curated/en/2014/07/19902948/strategic-information-revelation-capital-allocation http://hdl.handle.net/10986/19380 |
| Summary: | It is commonly believed that stock
prices help firms' managers make more efficient real
investment decisions, because they aggregate information
about fundamentals that is not otherwise known to managers.
This paper identifies a limitation to this view. It shows
that if informed traders internalize that firms use prices
as a signal, stock price informativeness depends on the
quality of managers' prior information. In particular,
managers with low quality information would like to learn
about their own fundamentals by relying on the information
aggregated in the stock price. However, in this case, the
profitability of trading falls for informed speculators, who
therefore reduce their trading volume, reducing the
informativeness of prices. As a result, stock prices are not
as useful in guiding capital toward its most productive use,
leading to inefficient investment decisions. Using a sample
of U.S. publicly traded companies between 1990 and 2010, the
paper documents a positive correlation between the quality
of managerial information and stock price informativeness.
Contrary to the conventional view that less informed
managers should rely more on stock prices when making
investment decisions, the author finds no differences in the
sensitivity of investment to stock prices for different
levels of managerial information. The evidence suggests that
while firms do learn from prices, the learning channel and
its effects on real investment are limited. |
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