The Limitations of Stock Market Efficiency: Price Informativeness and CEO Turnover

55 Pages Posted: 12 May 2009 Last revised: 14 May 2009

See all articles by Gary B. Gorton

Gary B. Gorton

Yale School of Management; National Bureau of Economic Research (NBER); Yale University - Yale Program on Financial Stability

Lixin Huang

Georgia State University

Qiang Kang

Florida International University (FIU) - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: May 2009

Abstract

Stock prices are more informative when the information has less social value. Speculators with limited resources making costly (private) information production decisions must decide to produce information about some firms and not others. We show that producing and trading on private information is most profitable in the stocks of firms with poor corporate governance -- precisely because it will not be acted upon -- and less profitable at firms with better corporate governance. To the extent that the information in the stock price is used for disciplining the CEO by the board of directors, the informed trader has a reduced incentive to produce the information in the first place. We test our model using the probability of informed trading (PIN) and the probability of forced CEO turnover in a simultaneous-equation system. The empirical results support the model predictions. Stock prices are efficient, but there is a limit to the disciplining role they can fulfill. We apply the model to evaluate the effects of the Sarbanes-Oxley Act of 2002.

Suggested Citation

Gorton, Gary B. and Huang, Lixin and Kang, Qiang, The Limitations of Stock Market Efficiency: Price Informativeness and CEO Turnover (May 2009). NBER Working Paper No. w14944. Available at SSRN: https://ssrn.com/abstract=1401789

Gary B. Gorton (Contact Author)

Yale School of Management ( email )

165 Whitney Ave
P.O. Box 208200
New haven, CT 06511
United States

HOME PAGE: http://mba.yale.edu/faculty/profiles/gorton.shtml

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Yale University - Yale Program on Financial Stability

165 Whitney Avenue
P.O. Box 208200
New Haven, CT 06520-8200
United States

Lixin Huang

Georgia State University ( email )

35 Broad Street
Atlanta, GA 30303-3083
United States

Qiang Kang

Florida International University (FIU) - Department of Finance ( email )

University Park
11200 SW 8th Street
Miami, FL 33199
United States

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