Blockholder Trading, Market Efficiency, and Managerial Myopia

Authors

  • ALEX EDMANS

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    • Alex Edmans is at the Wharton School, University of Pennsylvania. I am deeply grateful to my advisors, Stewart Myers, Dirk Jenter, Gustavo Manso, and Xavier Gabaix, for their support and guidance. I am indebted to an anonymous referee for numerous comments that significantly improved the paper, as well as an associate editor and the editor, Cam Harvey. This paper has also benefited from input by Prasun Agarwal; Franklin Allen; Jack Bao; Indraneel Chakraborty; Florian Ederer; Isil Erel; Chris Evans; Carola Frydman; Itay Goldstein; Li He; Cliff Holderness; Adam Kolasinski; Pavitra Kumar; Robert Marquez; Anna Obizhaeva; Weiyang Qiu; Robert Ready; Michael Roberts; Steve Ross; Alan Schwartz; Jeremy Stein; Luke Taylor; Masako Ueda; Jialan Wang; Paul Yan; and seminar participants at the 2008 Penn/NYU Conference on Law and Finance, the 2007 WFA meetings, the 2006 CEPR European Summer Symposium in Financial Markets, the 2006 FMA doctoral tutorial, Berkeley, Boston College, Dartmouth, Duke, Maryland, MIT, Northwestern, Notre Dame, NYU, UBC, UCLA, UNC, Wharton, and Yale. I acknowledge excellent research assistance from Qi Liu, and travel grants from the NYSE and the MIT Graduate Student Council. This paper was previously circulated as “Blockholders, Market Efficiency, and Managerial Myopia.”


ABSTRACT

This paper analyzes how blockholders can exert governance even if they cannot intervene in a firm's operations. Blockholders have strong incentives to monitor the firm's fundamental value because they can sell their stakes upon negative information. By trading on private information (following the “Wall Street Rule”), they cause prices to reflect fundamental value rather than current earnings. This in turn encourages managers to invest for long-run growth rather than short-term profits. Contrary to the view that the U.S.'s liquid markets and transient shareholders exacerbate myopia, I show that they can encourage investment by impounding its effects into prices.

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