Financial Markets and the Real Economy

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Even though no new capital is raised in secondary financial markets (buyers and sellers simply trade second-hand, already-issued securities), such markets can have significant effects on the real economy. Under the contracting channel, the manager’s pay or reputation is tied to the stock price, so trading makes the stock price more reflective of his actions and encourages him to take value-maximizing actions to begin with. Under the learning channel, the manager learns information from the stock price to guide his actions – for example, he uses the stock price as a signal of his investment opportunities to decide how much to invest.

Survey (Bond, Edmans, Goldstein ARFE 2012)