Market Efficiency, Managerial Compensation, and Real Efficiency
40 Pages Posted: 16 Mar 2006 Last revised: 2 May 2014
Date Written: March 2014
We examine how an exogenous improvement in market efficiency, which allows the stock market to obtain more precise information about the firm's intrinsic value, affects the shareholder-manager contracting problem, managerial incentives, and shareholder value. A key assumption in the model is that stock market investors do not observe the manager's pay-performance sensitivity ex ante. We show that an increase in market efficiency weakens managerial incentives by making the firm's stock price less sensitive to the firm's current performance. The impact on real efficiency and shareholder value varies depending on the composition of the firm's intrinsic value.
Keywords: Real efficiency, informational efficiency, pay-performance sensitivity
JEL Classification: G30, G31
Suggested Citation: Suggested Citation