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Firms and society 42 in theory all costs and benets

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Unformatted text preview: Lenders? 33 Aswath Damodaran 33 III. Firms and Financial Markets 34 ¨༊  In theory: Financial markets are efficient. Managers convey informaIon honestly and and in a Imely manner to financial markets, and financial markets make reasoned judgments of the effects of this informaIon on 'true value'. As a consequence- A company that invests in good long term projects will be rewarded. ¤༊  Short term accounIng gimmicks will not lead to increases in market value. ¤༊  Stock price performance is a good measure of company performance. ¤༊  ¨༊  In pracIce: There are some holes in the 'Efficient Markets' assumpIon. Aswath Damodaran 34 Managers control the release of informaIon to the general public 35 InformaIon management (Iming and spin): InformaIon (especially negaIve) is someImes suppressed or delayed by managers seeking a beCer Ime to release it. When the informaIon is released, firms find ways to “spin” or “frame” it to put themselves in the best possible light. ¨༊  Outright fraud: In some cases, firms release intenIonally misleading informaIon about their current condiIons and future prospects to financial markets. ¨༊  Aswath Damodaran 35 Evidence that managers delay bad news? 36 DO MANAGERS DELAY BAD NEWS?: EPS and DPS Changes- by Weekday 8.00% 6.00% 4.00% 2.00% 0.00% -2.00% -4.00% -6.00% Monday Tuesday Wednesday % Chg(EPS) Aswath Damodaran Thursday Friday % Chg(DPS) 36 Some criIques of market efficiency.. 37 ¨༊  ¨༊  Investor irraIonality: The base argument is that investors are irraIonal and prices oVen move for not reason at all. As a consequence, prices are much more volaIle than jusIfied by the underlying fundamentals. Earnings and dividends are much less volaIle than stock prices. ManifestaIons of irraIonality ¨༊  ¨༊  ¨༊  ReacIon to news: Some believe that investors overreact to news, both good and bad. Others believe that investors someImes under react to big news stories. An insider conspiracy: Financial markets are manipulated by insiders; Prices do not have any relaIonship to value. Short termism: Investors are short- sighted, and do not consider the long- term implicaIons of acIons taken by the firm Aswath Damodaran 37 Are markets short sighted and too focused on the near term? What do you think? 38 ¨༊  Focusing on market prices will lead companies towards short term decisions at the expense of long term value. a. b. ¨༊  Allowing managers to make decisions without...
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