Aswath Damodaran 31
III. Firms and Financial Markets
! In theory: Financial markets are efficient. Managers convey information
honestly and and in a timely manner to financial markets, and financial
markets make reasoned judgments of the effects of this information on 'true
value'. As a consequence-
- A company that invests in good long term projects will be rewarded.
- Short term accounting gimmicks will not lead to increases in market value.
- Stock price performance is a good measure of company performance.
! In practice: There are some holes in the 'Efficient Markets' assumption.
An efficient market is one where the market price reflects the true value of the
equity in the firm (and any changes in it). It does not imply perfection on the
part of markets, but it does imply a link between what happens to the stock price
and what happens to true value.
