Point of View: Contingent Choice Behavioral Models in the Presence of Information Uncertainty

Abstract

Executive Summary. Recent literature suggests that enhancing the quantity and/or quality of corporate disclosures may influence the non-diversifiable component of information risk for the firm, and hence, have nontrivial valuation implications. We propose a framework that argues a firm's disclosure level balances the potential cost of capital benefits from selective revelation and the disutility of distress, which in turn is a function of the potential costs of obfuscation. The real estate investment trust (REIT) industry provides an experimentally appropriate backdrop for our position due to its generally heavy reliance on external financing and thus its heightened market exposure to priced information risk. Using three potential measures of the opacity of a REIT's annual report: the Flesch-Kincaid Grade Level, the Flesch Reading Ease Score, and the number of words contained in the report, we propose that capital-constrained firms, particularly those with growth ambitions, should be uniquely sensitive to the transparency of their corporate disclosures as opacity materially influences the firm's cost of capital.