NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Information Aggregation, Investment, and Managerial Incentives

Elias Albagli, Christian Hellwig, Aleh Tsyvinski

NBER Working Paper No. 17330
Issued in August 2011
NBER Program(s):   AP   CF   EFG

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.

download in pdf format
   (545 K)

email paper

This paper is available as PDF (545 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w17330

Users who downloaded this paper also downloaded these:
Albagli, Hellwig, and Tsyvinski w17548 A Theory of Asset Pricing Based on Heterogeneous Information
Baker and Wurgler w17333 Behavioral Corporate Finance: An Updated Survey
Asker, Farre-Mensa, and Ljungqvist w17394 Comparing the Investment Behavior of Public and Private Firms
Del Guercio and Reuter w17491 Mutual Fund Performance and the Incentive to Generate Alpha
Frydman and Jenter w16585 CEO Compensation
 
Publications
Activities
Meetings
NBER Videos
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us