Meaning and credibility of forward-looking disclosures: evidence from an entry game

Abstract

Purpose- The study aims to find and analyze the equilibria for the forward-looking disclosures using game theory and to investigate the information signaling mechanism of such disclosures focusing on the credibility and meaning of them. Methodology- The study uses a cheap-talk game setting as a special form of signaling game in which forward-looking information are examined as costless, nonbinding and non-verifiable claims sent to a potential Entrant by the Incumbent firm. Findings- Equilibria are derived and neologism-proofness refinement is applied to rule out the implausible equilibria. Informative equilibrium exists only if the players’ preferences are more closely aligned. Entrant’s strategy is critical to determine which equilibrium is plausible. Under entry strategy, informative equilibrium is plausible and rules out the uncommunicative equilibria. However, under non-entry strategy, informative equilibrium fails to be plausible. Conclusion- Only under the entry strategy, the Incumbent should disclose its private information, whereas, under non-entry strategy, the Incumbent should not reveal its private information. Furthermore, the uncommunicative equilibria indicate that despite the Entrant’s pessimism about future, the Entrant prefers to choose entry strategy when the entry cost is sufficiently low. Contrarily, despite the Entrant’s optimism, non-entry becomes optimal when the entry cost is relatively high.