Market Liquidity and Performance Monitoring

This paper shows that the stock price incorporates performance information that cannot be extracted from the firm's current or future profit data. The additional information is useful for structuring managerial incentives. The amount of information contained in the stock price depends on the liquidity of the market. Concentrated ownership, by reducing market liquidity, reduces the benefits of market monitoring. Integration is associated with weakened managerial incentives and less market monitoring. The paper also studies the equilibrium size of the stock market as a function of investor preferences and the available amounts of long- and short-term capital. Copyright 1993 by University of Chicago Press.