What Do Stock Price Levels Tell Us about the Firms?
March 5, 2013 Leave a comment
What Do Stock Price Levels Tell Us about the Firms?
Konan Chan National Chengchi University (NCCU)
Fengfei Li University of Hong Kong
Tse-Chun Lin University of Hong Kong – Faculty of Business and Economics
Ji-Chai Lin Louisiana State University, Baton Rouge – E.J. Ourso College of Business Administration
February 26, 2013
Abstract:
What do stock price levels tell us about the firms? Based on market microstructure theories, this paper hypothesizes that, ceteris paribus, high stock price levels impede informed trading on the stocks and reduce price informativeness because uninformed trading is needed to facilitate informed trading, and high stock prices may impose budget constraints on uninformed investors and limit their risk sharing capacity. This hypothesis suggests that since their stock prices are less informative, higher-price stocks’ listed options are more appealing to informed traders. Indeed, controlling for firm size, analyst coverage, and other determinants, we find that stock price informativeness about future earnings is lower and Roll et al.’s (2010) O/S, the relative trading of options over stock, is higher for firms with higher stock price levels. We also find that higher-price firms have lower investment sensitivity to stock price. For robustness checks, we further use a split sample as an event study and find evidence consistent with our hypothesis that firms can use stock splits to improve informed trading on their stocks and enhance price informativeness. Our findings imply that stock price levels matter in price informativeness and in where traders choose to trade. Furthermore, when firms need less feedback from the market, they tend to keep their stock prices at higher levels.
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