Incentivizing Effort and Informing Investment: The Dual Role of Stock Prices

75 Pages Posted: 3 Nov 2021 Last revised: 8 Mar 2022

See all articles by Snehal Banerjee

Snehal Banerjee

University of California, San Diego (UCSD) - Rady School of Management

Jesse Davis

University of North Carolina (UNC) at Chapel Hill - Finance Area

Naveen Gondhi

INSEAD

Date Written: November 2, 2021

Abstract

Stock prices reflect managerial performance and aggregate investor information about investment opportunities. We show that these dual roles are in tension: when prices are more informative about future opportunities, they may be less effective at incentivizing managerial effort. Firm value can decrease with price informativeness, but increase with ex-post inefficient investment rules and lower transparency. The relation among price informativeness, performance sensitivity and duration of managerial compensation, delegation, and firm value depends crucially on the importance of investment opportunities relative to managerial performance. Standard empirical measures of efficiency can be misleading because they ignore the dual role of prices.

Keywords: contracting, feedback effect, optimal compensation, price efficiency, transparency

JEL Classification: D8, G1

Suggested Citation

Banerjee, Snehal and Davis, Jesse and Gondhi, Naveen, Incentivizing Effort and Informing Investment: The Dual Role of Stock Prices (November 2, 2021). Available at SSRN: https://ssrn.com/abstract=3955129 or http://dx.doi.org/10.2139/ssrn.3955129

Snehal Banerjee (Contact Author)

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States

Jesse Davis

University of North Carolina (UNC) at Chapel Hill - Finance Area

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

Naveen Gondhi

INSEAD ( email )

Boulevard de Constance
77305 Fontainebleau Cedex
France

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