Chicanery , Intelligence , and Financial Market Equilibrium

Chicanery, Intelligence, and Financial Market Equilibrium In this paper, we provide perspectives on how disclosure policies and managerial intelligence interact to influence stock prices, firm values, and the liquidity of financial markets. In addition to the natural premise that intelligent managers positively influence firm values, we adopt two alternative perspectives on managerial intelligence. First, intelligent managers, precisely because of their intellect, are likely to be very successful in disseminating misleading impressions of a company’s true value. Second, agents with intelligence have high reservation wages which increases their incentives to overstate firm value. These two features cause the incentive to make misleading disclosures to increase in managerial intelligence. We show that given feedback from stock prices to cash flows, such confounding actions may actually improve ex post firm values. We then show that agents may have inadequate incentives to investigate and acquire information in firms run by disingenuous but intelligent managers. This ensures that firms where managers fudge financial reports can be very liquid with little information asymmetry in financial markets but substantial information asymmetry between management and outside investors.