Attracting attention: Cheap managerial talk and costly market monitoring

Abstract

This paper provides a theory of informal communication between firms and markets that emphasizes the role that agency conflicts play in firms ’ disclosure policies. Since managers ’ information is in part the result of their past actions, managerial compensation and the firm’s disclosure policy are two intrinsically related aspects of corporate governance. In the model, the information disclosed by managers attracts market attention and guides investors in their investigation efforts. Optimal incentive compensation, however, discourages managers from attracting market attention unless the firm is severely undervalued. The analysis relates the credibility of managerial announcements to the use of stock based compensation, the presence of informed trading, and the level of liquidity in the market. The analysis can explain why apparently innocuous corporate events (e.g., a stock dividend or a name change) can affect a firm’s stock price, and suggests that an adequate use of incentive compensation can foster the communication of managerial information to the market.