Outside Investor Access to Top Management: Market Monitoring versus Stock Price Manipulation

In recent decades, an increase in the importance of intangible assets, especially in the technology sector, has reduced how much information stock market participants can take away from accounting numbers. This means market participants increasingly rely on managers of public firms to obtain information about the firms’ future performance. Managers often provide additional voluntary disclosure to market participants in the form of special reports or investor conference calls and presentations. This can make a firm’s stock price more informative, thereby strengthening manager incentives to increase the firm’s value. But it also gives managers the opportunity to influence the value of their pay tied to the firm’s stock price in a way that reduces the firm’s value.

This trade-off is important and needs to be evaluated empirically. However, this cannot be done without first identifying the relevant economic channels in theory. To that end, this paper develops a model of firm-value maximization. The model shows how voluntary disclosure, manager compensation, manager stock-price manipulation, firm cost of capital and firm capital structure are related in equilibrium.

A significant part of variation in top-manager pay is known to be unrelated to performance. I assume the reason for this is that managers differ in their ability to manipulate voluntary disclosure and thus the firm’s stock price. A key cross-sectional prediction is that voluntary disclosure is related negatively to the cost of capital but positively to manager manipulation. The analysis thus implies that cost of capital is not a good measure of frictions in accounting or governance.