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Information Frictions in Financial Markets

Paper Session

Saturday, Jan. 6, 2018 2:30 PM - 4:30 PM

Loews Philadelphia, Regency Ballroom C2
Hosted By: American Finance Association
  • Chair: Victoria Vanasco, Stanford University

Delegated Learning in Asset Management

Michael Sockin
,
University of Texas-Austin
Mindy Z. Xiaolan
,
University of Texas-Austin

Abstract

We develop a tractable framework of delegated asset management with flexible information acquisition in a multi-asset economy in which fund managers face moral hazard in portfolio allocation decisions. We explore the features of the optimal affine compensation contract for fund managers, in which benchmarking arises endogenously as part of their optimal compensation. In the equilibrium with delegated learning, asset prices reflect both the acquired private information of fund managers and their desire to hedge their exposure to the benchmark. We
show a potential gap between our model-implied measure and several widely-adopted empirical statistics intended to capture managerial ability. In a multi-period extension, we propose a new performance measure of fund manager skill.

The Effect of Diversification on Price Informativeness and Governance

Alex Edmans
,
London Business School
Doron Levit
,
University of Pennsylvania
Devin Reilly
,
Analysis Group

Abstract

An asset's price informativeness and fundamental value depends on an informed investor's holdings of other, potentially unrelated, assets. If an asset is sold by a concentrated owner, the price decline is low since the sale may be motivated by a liquidity shock. A diversified owner has the choice of which assets to sell upon a shock. Thus, a sale is more revealing of poor asset quality, increasing price informativeness and strengthening governance through both exit (since the price decline upon a sale is greater) and voice (since the payoff from "cutting and running" is lower). The model highlights a channel through which diversification may strengthen governance, in contrast to conventional wisdom that it necessarily weakens it by spreading an investor too thinly.

When Words Speak Louder Without Actions

Doron Levit
,
University of Pennsylvania

Abstract

This paper studies communication and intervention as mechanisms of corporate governance. I develop a model in which a privately informed principal can intervene in the decisions of the agent if the latter disobeys her instructions. The main result shows that intervention can prompt disobedience and harm communication. Therefore, less information can be revealed by the principal in equilibrium when the principal has the ability to intervene in the agent's decisions. In this respect, words do speak louder without actions. The model is applied to managerial leadership, corporate boards, private equity, and shareholder activism.

Inside and Outside Information: Fragility and Stress Test Design

Daniel Quigley
,
University of Oxford
Ansgar Walther
,
University of Warwick

Abstract

We analyze a model of strategic communication where uninformed parties observe verifiable inside information, which is disclosed strategically by self-interested parties, as well as outside information that is beyond insiders' control. A central application is the design of financial stress tests (outside information) that are disclosed by financial regulators, and which interact with banks' endogenous choice of transparency (inside information). For a range of parameters, the classic “unraveling” spiral works in reverse, and information becomes fragile: Second-order changes in the distribution of outside information can trigger first-order reductions in inside disclosures. We show that optimal stress tests must satisfy a minimum standard of transparency. We further show that the importance of outside information hinges on the shape of insiders' payoff functions, which leads to new testable predictions for corporate disclosures.
Discussant(s)
Giorgia Piacentino
,
Columbia University
Gilles Chemla
,
Imperial College London
Sergei Kovbasyuk
,
Einaudi Institute for Economics and Finance
Nadya Malenko
,
Boston College
JEL Classifications
  • G0 - General