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Market-Based Solutions to Vital Economic Issues
Research
Nov 3, 2021

Incentivizing Effort and Informing Investment: The Dual Role of Stock Prices

Abstract

Stock prices reflect firm performance and aggregate investor information about investment opportunities. We show that these dual roles are in tension: when prices are more informative about future investment, they are less effective at incentivizing managerial effort. Overall firm value need not increase with price informativeness; both decreasing transparency and allowing for ex-post inefficient investment can increase firm value. We show that standard empirical measures of price efficiency are incomplete and derive testable predictions for the price-sensitivity and composition of managerial compensation.


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