Market efficiency, managerial compensation, and real efficiency

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 th...

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Bibliographic Details
Published in:Journal of corporate finance (Amsterdam, Netherlands) Netherlands), 2014-12, Vol.29, p.561-578
Main Authors: Singh, Rajdeep, Yerramilli, Vijay
Format: Article
Language:English
Subjects:
Business valuation
Efficiency
Efficient markets
Executive compensation
Market efficiency
Pay-performance sensitivity
Real efficiency
Securities markets
Shareholders wealth
Stock prices
Stockholders
Studies
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Summary: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. •Increase in market efficiency makes stock prices more informationally efficient.•But, how does it affect shareholder-manager contracting problem, managerial incentives and shareholder value?•It weakens managerial incentives by making stock price less sensitive to manager’s effort.•We show that its effect on real efficiency and shareholder value is more nuanced, and depends on the composition of firm’s intrinsic value.
ISSN:0929-1199
1872-6313
DOI:10.1016/j.jcorpfin.2014.03.006