Stock Prices and Scandals
By Arnold Kling
Jeff Madrick describes disparate economic views on whether stock prices should guide managers.
The modern theory typically depends on the idealized efficient-markets theory, which asserts that at any given moment the stock price is not only the best measure we have of the future value of a company, but usually an accurate one. The stock price will thus send the right signals to reward appropriate managerial behavior.
…Mr. Jensen, however, began to see something he had not fully thought about. “What we learned from the 1990’s,” he said in an interview, “is that when a company’s stock is overvalued it sets in motion a set of organizational pressures that can destroy rather than create shareholder value.”
…But Mr. Jensen remained dismissive of views that corporations owe anything to other constituencies, like employees, and of “score carding,” which balances a range of measures of performance.
I think that what Jensen would say is that even though stock markets are imperfect, the stock price still provides a better guide to managers than other performance measures, which also have their flaws.
For Discussion. Some people have suggested that incentive stock options should be indexed to overall market performance, so that managers would be rewarded and punished for how their company performs relative to the market, rather than for stock market behavior as a whole. Would this solve some of the concerns expressed by Jensen and others? What adverse incentives might it create?