The Limitations of Stock Market Efficiency: Price Informativeness and CEO Turnover

Gary Gorton, Lixin Huang () and Qiang Kang

No 14944, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: G0 G1 G14 G3 (search for similar items in EconPapers)
Date: 2009-05
New Economics Papers: this item is included in nep-bec and nep-cta
Note: AP CF
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Citations: View citations in EconPapers (2)

Published as Gary B. Gorton & Lixin Huang & Qiang Kang, 2017. "The Limitations of Stock Market Efficiency: Price Informativeness and CEO Turnover," Review of Finance, European Finance Association, vol. 21(1), pages 153-200.

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