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RFS Advance Access published online on September 20, 2009
Review of Financial Studies, doi:10.1093/rfs/hhp059
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© The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org

Market-Based Corrective Actions

Philip Bond
University of Pennsylvania

Itay Goldstein
University of Pennsylvania

Edward Simpson Prescott
Federal Reserve Bank of Richmond

Send correspondence to Philip Bond, Wharton School, University of Pennsylvania, 2300 Steinberg Hall-Dietrich Hall, 3620 Locust Walk, Philadelphia, PA 19104; telephone: (215) 898-2370; fax: 215-898-6200. E-mail: pbond{at}wharton.upenn.edu

JEL Classification: D53, D80, G14, G21, G28, G34


  Abstract

Many economic agents take corrective actions based on information inferred from market prices of firms’ securities. Examples include directors and activists intervening in the management of firms and bank supervisors taking actions to improve the health of financial institutions. We provide an equilibrium analysis of such situations in light of a key problem: if agents use market prices when deciding on corrective actions, prices adjust to reflect this use and potentially become less revealing. We show that market information and agents’ information are complementary, and discuss measures that can increase agents’ ability to learn from market prices.

We thank Beth Allen, Franklin Allen, Mitchell Berlin, Alon Brav, Thomas Chemmanur, Douglas Diamond, Alex Edmans, Andrea Eisfeldt, Gary Gorton, Wei Jiang, Richard Kihlstrom, Rajdeep Sengupta, Holger Spamann, Annette Vissing-Jorgensen, an anonymous referee, and the editor (Paolo Fulghieri) for their comments and suggestions. We also thank seminar participants at numerous universities and conferences for their comments and suggestions. The views expressed in this paper do not necessarily reflect the views of the Federal Reserve Bank of Richmond or the Federal Reserve System.


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