TY  - JOUR
AU  - Dow,James
AU  - Gorton,Gary
TI  - Stock Market Efficiency and Economic Efficiency: Is There a Connection?
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 5233
PY  - 1995
Y2  - August 1995
UR  - http://www.nber.org/papers/w5233
L1  - http://www.nber.org/papers/w5233.pdf
N1  - Author contact info:
James Dow
London Business School
Sussex Place
Regent's Park, London
NW1 4SA  UK
Tel: 4402072625050 Ext3317
Fax: 4402077243317
E-Mail: jdow@london.edu

Gary B. Gorton
Yale School of Management
135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
Fax: 203/432-8931
E-Mail: Gary.Gorton@yale.edu
AB  - In a capitalist economy prices serve to equilibrate supply and demand for goods and services, continually changing to reallocate resources to their most efficient uses.  However, secondary stock market prices, often viewed as the most 'informationally efficient' prices in the economy, have no direct role in the allocation of equity capital since managers have discretion in determining the level of investment.  What is the link between stock price informational efficiency and economic efficiency? We present a model of the stock market in which: (i) managers have discretion in making investments and must be given the right incentives; and (ii) stock market traders may have important information that managers do not have about the value of prospective investment opportunities.  In equilibrium, information in stock prices will guide investment decisions because managers will be compensated based on informative stock prices in the future. The stock market indirectly guides investment by transferring two kinds of information: information about investment opportunities and information about managers' past decisions.  The fact that stock prices only have an indirect role suggests that the stock market may not be a necessary institution for the efficient allocation of equity. We emphasize this by providing an example of a banking system that performs as well.
ER  -