The Real Costs of Financial Efficiency When Some Information Is Soft

Review of Finance, Forthcoming

45 Pages Posted: 26 Aug 2013 Last revised: 14 May 2016

Alex Edmans

London Business School - Institute of Finance and Accounting; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Mirko Stanislav Heinle

University of Pennsylvania - Accounting Department

Chong Huang

University of California, Irvine - Paul Merage School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: May 3, 2016

Abstract

This paper shows that improving financial efficiency may reduce real efficiency. While the former depends on the total amount of information available, the latter depends on the relative amounts of hard and soft information. Disclosing more hard information (e.g. earnings) increases total information, raising financial efficiency and reducing the cost of capital. However, it induces the manager to prioritize hard information over soft by cutting intangible investment to boost earnings, lowering real efficiency. The optimal level of financial efficiency is non-monotonic in investment opportunities. Even if low financial efficiency is desirable to induce investment, the manager may be unable to commit to it. Optimal government policy may involve upper, not lower, bounds on financial efficiency.

Keywords: Financial efficiency, real efficiency, managerial myopia, investment, disclosure, cost of capital

JEL Classification: G12, G14, G18, G31, G38

Suggested Citation

Edmans, Alex and Heinle, Mirko Stanislav and Huang, Chong, The Real Costs of Financial Efficiency When Some Information Is Soft (May 3, 2016). Review of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2316194 or http://dx.doi.org/10.2139/ssrn.2316194

Alex Edmans (Contact Author)

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Mirko Stanislav Heinle

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Chong Huang

University of California, Irvine - Paul Merage School of Business ( email )

Irvine, CA 92697-3125
United States

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