Firm Investment and Price Informativeness

Abstract

I theoretically investigate how the informational content of stock prices is affected by the structure of firms' capital investment decisions. The efficiency of stock prices is determined by the weight firms attach to private information and by the extent to which investment is predictable. Both factors attract informed trading and lead to more revealing prices. The model predicts that i) individual stock prices should be more informative than aggregate prices, ii) firms with better managers should have more informative prices, iii) a higher degree of stock-based compensation reduces price efficiency and iv) more heterogenous markets are less price efficient.

Keywords: price informativeness, real efficiency, feedback effects

JEL Classification: D61, D62, G14, G30