Price informativeness and corporate investment: a model of costly manipulation and share repurchases

Abstract

We characterize how managers can curb manipulation by signaling information via stock repurchases in an environment with costly short selling and feedback effects from trading to firms’ access to capital. Without repurchases, manipulation coexists with informed trading at low shorting costs, reducing price informativeness and firm investment. Manipulation becomes less profitable as shorting costs increase, making prices more informative and boosting investment if speculators are less informed. Incentives to manipulate cease to exist at moderate short selling costs, but making shorting more costly reduces price informativeness and firm investment. Our model shows how contracts that pre-commit funding and condition future investment on stock prices can induce managers to eliminate manipulation through stock repurchases, facilitating optimal investment policies. An important policy implication is that when stock repurchases are allowed and shorting costs are low, short selling bans will typically reduce investment efficiency.