Moral hazard with excess returns

We consider a public firm characterized by a moral hazard problem. A distinguished player is a CEO or activist shareholder who (i) is unrestricted to trade shares and (ii) has discretion to increase the value of this firm by exerting costly effort. von Lilienfeld-Toal and Runzi (J Finance 69(3):1013-1050, 2014) investigate and confirm the empirical relevance of both these properties. This article shows that a distinguished player cannot be "priced in" correctly. In particular, such a firm is traded at a discount below its equilibrium value in a market equilibrium. Buyers can systematically earn excess returns on their investment. This prediction is indeed consistent with substantial positive abnormal returns for distinguished player firms within the S & P500 and S & P1500 sample reported in von Lilienfeld-Toal and Runzi (J Finance 69(3):1013-1050, 2014).