Working Paper: NBER ID: w14944
Authors: Gary B. Gorton; Lixin Huang; Qiang Kang
Abstract: Stock prices are more informative when the information has less social value. Speculators with limited resources making costly (private) information production decisions must decide to produce information about some firms and not others. We show that producing and trading on private information is most profitable in the stocks of firms with poor corporate governance -- precisely because it will not be acted upon -- and less profitable at firms with better corporate governance. To the extent that the information in the stock price is used for disciplining the CEO by the board of directors, the informed trader has a reduced incentive to produce the information in the first place. We test our model using the probability of informed trading (PIN) and the probability of forced CEO turnover in a simultaneous-equation system. The empirical results support the model predictions. Stock prices are efficient, but there is a limit to the disciplining role they can fulfill. We apply the model to evaluate the effects of the Sarbanes-Oxley Act of 2002.
Keywords: stock market efficiency; CEO turnover; price informativeness; corporate governance
JEL Codes: G01; G14; G3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Informed Trading (PIN) (G14) | Forced CEO Turnover (FORCE TURN) (G34) |
| Forced CEO Turnover (FORCE TURN) (G34) | Informed Trading (PIN) (G14) |
| Informativeness of Stock Prices (G14) | Social Value of Information (D83) |
| Corporate Governance Quality (G38) | Nature of Information Produced by Traders (D83) |
| CEO Entrenchment (G34) | Informed Trading (G14) |
| CEO Entrenchment (G34) | Forced CEO Turnover (FORCE TURN) (G34) |
| Board Monitoring Effort (G34) | Informed Trading (PIN) (G14) |
| Informed Trading (PIN) (G14) | Board Monitoring Effort (G34) |