The Short-Termism Trap: Catering to Informed Investors

Abstract

Does the stock market exert short-term pressure on listed firms, do they respond, and is this response value reducing? Informative stock prices increase firm value. In our model, they reduce the agency cost of incentivizing managers. Also, short project maturity improves stock price informativeness by catering to informed investors who prefer short-term assets. However, since informed trading capital is a scarce resource, attracting informed investors cannot increase an individual firm's price informativeness in equilibrium: it simply destroys shareholder value. This "short-termism trap" can destroy large amounts of shareholder value, potentially up to 100% of the benefits of stock market listing.

Keywords: informed trading, managerial compensation, short-termism, optimal contracting, race to the bottom, strategic complementarities

JEL Classification: G14, G32, G38