Government Intervention and Information Aggregation by Prices

Governments intervene in firms’ lives in a variety of ways. To enhance the efficiency of government intervention, many researchers and policy makers call for governments to make use of information contained in stock market prices. However, price informativeness is endogenous to government policy. We analyze government policy in light of this endogeneity. In some cases, it is optimal for a government to commit to limit its reliance on market prices to avoid harming the aggregation of information into market prices. For similar reasons, it is optimal for a government to limit transparency in some dimensions. OUR PAPER IS MOTIVATED BY TWO key observations. First, governments play an important role in the lives of firms and financial institutions, and take actions that have significant implications for these firms’ cash flows and stock prices. Second, government actions often follow financial market movements; and, closely related, many government officials view market prices as a useful source of information, and a number of policy proposals advocate making more explicit use of this information. In this paper we analyze the implications of a government’s use of market information in light of a key economic force: market prices reflect not only ∗Bond is with the Foster School, University of Washington. Goldstein is with the Wharton School, University of Pennsylvania. We thank Campbell Harvey (the Editor); an anonymous referee; an Associate Editor; along with Viral Acharya; Michael Fishman; William Fuchs; Qi Liu; Vincent Maurin; Adriano Rampini; Jean-Charles Rochet; Duane Seppi; Laura Veldkamp; and seminar audiences at the Bank of Israel, Dartmouth College, the Federal Reserve Banks of Chicago, Minneapolis, and New York, the International Monetary Fund, MIT, Michigan State University, New York University, the University of California at Berkeley, the University of California at Irvine, the University of Delaware, the University of Illinois at Chicago, the University of Maryland, the University of North Carolina at Chapel Hill, the University of Waterloo, the University of Wisconsin, Washington University in St Louis, York University, the Financial Crisis Workshop at Wharton, the American Economic Association meetings, the EUI Economic Policy after the Financial Crisis Workshop, the FIRS Conference, the NBER Summer Institute on Capital Markets and the Economy, the Chicago-Minnesota Accounting Theory Conference, the Theory Workshop on Corporate Finance and Financial Markets, the American Finance Association meetings, the NY Fed-NYU Financial Intermediation Conference, the University of Washington Summer Finance conference, the Society for Economic Dynamics conference, and the IDC Summer Workshop for helpful comments. Bond thanks the Cynthia and Bennett Golub Endowed Faculty Scholar Award Fund for financial support. All errors are our own. DOI: 10.1111/jofi.12303