Talking Up Liquidity: Insider Trading and Investor Relations
45 Pages Posted: 4 Dec 2002
Date Written: October 20, 2002
Managements ("insiders") of many corporations, especially small or newly public firms, invest considerable resources in investor relations such as voluntary disclosures and courting analyst coverage. We develop a model to explore the role of such costly investments and the incentives of insiders to undertake them. In contrast to existing theories, we point out that insiders may undertake such investments not necessarily to improve the share price, but to enhance the liquidity of their block of shares in case they have to sell their equity stakes for liquidity reasons. This leads to a divergence of interest between insiders and dispersed outside shareholders regarding investor relations. The costs of investor relations are paid by all shareholders, though dispersed shareholders care little about market liquidity because of their small holdings. Our model predicts that the demographics of insiders (e.g. liquidity needs, size of equity stakes) are determinants of the extent of investor relations across firms.
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