Abstract
This paper shows that real decisions depend not only on the total amount of information in prices, but the source of this information -- a manager learns from prices when they contain information not possessed by him. We use the staggered enforcement of insider trading laws across 27 countries as a shock to the source of information that leaves total information unchanged: enforcement reduces (increases) managers' (outsiders') contribution to the stock price. Consistent with the predictions of our theoretical model, enforcement increases investment-q sensitivity, even when controlling for total price informativeness. The effect is larger in industries where learning is likely to be stronger, and in emerging countries where outsider information acquisition rises most post-enforcement. Enforcement does not increase the sensitivity of investment to cash flow, a non-price measure of investment opportunities. These findings suggest that extant measures of price efficiency should be rethought when evaluating real efficiency.
Highlights
R We thank the Referee (Thomas Philippon), the Editor (Toni Whited), Jennie Bai, Karthik Balakrishnan, Taylor Begley, Bastian von Beschwitz, Stijn Claessens, Valentin Dimitrov, Laurent Frésard, Itay Goldstein, Todd Gormley, Kose John, Marcin Kacperczyk, Ralph Koijen, Randall Morck, Joseph Piotroski, Alexi Savov, Henri Servaes, Rui Silva, Luke Taylor, and conference/seminar participants at the AFA, Arizona State University, Conference on Financial Economics and Accounting, ECB, Frankfurt School of Finance and Management, Imperial CEPR Conference, Lancaster, London Business School, Mannheim, National Taiwan University Conference, NHH Corporate Finance Conference, Rising Star Conference, Temple, UT Austin, and Wharton for valued input
We find that insider trading enforcement (ITE) leads to an increase in investmentq sensitivity that is significant at the 5% level
This paper tests the hypothesis that the real effects of financial markets—the effect of stock prices on real decisions—depend not on the total amount of information in prices but the amount of information in prices not already known to the decision maker
Summary
R We thank the Referee (Thomas Philippon), the Editor (Toni Whited), Jennie Bai, Karthik Balakrishnan, Taylor Begley, Bastian von Beschwitz, Stijn Claessens, Valentin Dimitrov, Laurent Frésard, Itay Goldstein, Todd Gormley, Kose John, Marcin Kacperczyk, Ralph Koijen, Randall Morck, Joseph Piotroski, Alexi Savov, Henri Servaes, Rui Silva, Luke Taylor, and conference/seminar participants at the AFA, Arizona State University, Conference on Financial Economics and Accounting, ECB, Frankfurt School of Finance and Management, Imperial CEPR Conference, Lancaster, London Business School, Mannheim, National Taiwan University Conference, NHH Corporate Finance Conference, Rising Star Conference, Temple, UT Austin, and Wharton for valued input. When prices are more informative, outside investors suffer less information asymmetry As a result, they are more willing to provide capital to firms in primary financial markets, facilitating investment (Stiglitz and Weiss, 1981). They are more willing to provide capital to firms in primary financial markets, facilitating investment (Stiglitz and Weiss, 1981) Under this channel, the extent to which financial markets support capital raising, and real investment, depends on the total amount of information in prices. In a recent survey, Bond et al (2012) term this notion Forecasting Price Efficiency (FPE), i.e., the extent to which prices predict fundamental values Due to this conventional view, regulatory changes (e.g., short-sale constraints and transaction taxes) are typically evaluated according to their likely impact on total price informativeness
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