WHEN MANAGERS COVER THEIR POSTERIORS - MAKING THE DECISIONS THE MARKET WANTS TO SEE

The stock market has opinions as to what choices firms should make. We show that concern for current share prices may Lead managers to make these choices rather than those suggested by their own superior inform ation. Even when arbitrarily many privately informed firms have to mak e a similar decision, the market's ''prejudices'' may still prevail. W e compare the distortions that arise from share-price maximization wit h those due to herd behavior among profit-maximizing firms, and show t hat the former results in strictly less efficient use of information.