Market Efficiency, Managerial Compensation, and Real Efficiency

40 Pages Posted: 16 Mar 2006 Last revised: 2 May 2014

Rajdeep Singh

University of Minnesota - Twin Cities - Carlson School of Management

Vijay Yerramilli

University of Houston, C. T. Bauer College of Business

Date Written: March 2014

Abstract

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

Singh, Rajdeep and Yerramilli, Vijay, Market Efficiency, Managerial Compensation, and Real Efficiency (March 2014). Journal of Corporate Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=891298 or http://dx.doi.org/10.2139/ssrn.891298

Rajdeep Singh (Contact Author)

University of Minnesota - Twin Cities - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States
612-624-1061 (Phone)
612-626-1335 (Fax)

HOME PAGE: http://umn.edu/~rajsingh

Vijay Yerramilli

University of Houston, C. T. Bauer College of Business ( email )

Houston, TX 77204
United States
713-743-2516 (Phone)

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