Price Discreteness and Investment to Price Sensitivity

Abstract

We study the effects of the tick size on stock price informativeness about future investment. Using the Tick Size Pilot Program as a controlled experiment, we find that an increase in the tick size increases the strength of Tobin’s q (a standardized measure of prices) to predict future investment. The increase in investment–q sensitivity is concentrated in firms that experience a reduction in the magnitude of market reactions to earnings announcements, an increase of EDGAR downloading volume, or a reduction in algorithmic trading. These findings suggest that a wider tick size increases the acquisition of information on firm fundamentals and consequently price informativeness about future investment decisions. The investment–q sensitivity also increases more when managers have stronger incentives to learn from stock prices, suggesting that some of the added information with a wider tick size is new to managers and therefore has a real effect on corporate investments.