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Strategic information revelation and capital allocation, Volume 1
 
Author:Pedraza Morales, Alvaro; Country:World;
Date Stored:2014/07/31Document Date:2014/07/01
Document Type:Policy Research Working PaperSubTopics:Markets and Market Access; Emerging Markets; Economic Theory & Research; Debt Markets; Investment and Investment Climate
Language:EnglishMajor Sector:Finance
Rel. Proj ID:1W-Lessons From The Global Crisis And The Recovery Process -- -- P146223;Region:The World Region
Report Number:WPS6995Sub Sectors:Microfinance; SME Finance; Housing finance; Banking; Capital markets
Collection Title:Policy Research working paper ; no. WPS 6995Volume No:1

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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