The Speed of Communication

Abstract

We study how information travels in the financial marketplace via word-of-mouth communication. Our innovation is to use cross-industry stock-financed mergers and acquisitions (M&As) as a source of plausibly exogenous variation in an investor’s portfolio composition and subsequent information-gathering activity. Specifically, we conjecture that once endowed with shares of the acquirer firm, investors in the target firm pay greater attention to the acquirer firm’s industry, which, in turn, generates additional trading activity in the acquirer industry. To the extent that any newly gained industry perspective spreads through word-of-mouth communication, we may observe higher levels of trading activity in the acquirer industry not only by target investors but also by their neighbors and their neighbors’ neighbors. Our analysis supports and builds on this assumption and uses retail-investor-trading records to trace out the “contagion” of acquirer-industry trading to describe the rate at which information spreads in financial markets and how that rate varies with both characteristics of the underlying information and characteristics of the senders and receivers of such information. than the effective communication rate in the reverse direction.

Keywords: Social Interaction, Word-of-Mouth, Information Diffusion

JEL Classification: G11, G12, G14, G20