The Invisible Hand in the Dark : The Disciplinary Effect of Dark Pools on Firm Overinvestment

We propose that the availability of dark pools incentivizes informed traders to acquire information ex-ante and thus induces stronger monitoring effects on corporate decisions. Utilizing the trade-at rule provision in the SEC’s Tick Size Pilot Program, we find that restrictions on dark pool trading lead to higher levels of corporate overinvestment for medium- and small-cap securities. The results are more pronounced for firms with a larger short-selling flow before the Program. The overinvestment due to the restrictions in dark trading worsens the firms’ future performance. Overall, we identify a novel external governance mechanism via informed trading in the dark pools