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The Source of Information in Prices and Investment-Price Sensitivity

54 Pages Posted: 15 Jan 2016 Last revised: 24 Dec 2016

Alex Edmans

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

Sudarshan Jayaraman

University of Rochester - Simon Business School

Jan Schneemeier

Indiana University - Kelley School of Business

Date Written: December 19, 2016

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.

Keywords: Financial Efficiency; Real Efficiency; Real Effects of Financial Markets; Insider Trading

JEL Classification: G14, G15, G31

Suggested Citation

Edmans, Alex and Jayaraman, Sudarshan and Schneemeier, Jan, The Source of Information in Prices and Investment-Price Sensitivity (December 19, 2016). Journal of Financial Economics (JFE), Forthcoming; Simon Business School Working Paper No. FR 16-01. Available at SSRN: https://ssrn.com/abstract=2715192 or http://dx.doi.org/10.2139/ssrn.2715192

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

Sudarshan Jayaraman

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

Jan Schneemeier

Indiana University - Kelley School of Business ( email )

1275 E 10th St
Bloomington, IN 47405
United States

HOME PAGE: http://www.jan-schneemeier.com

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