Reputation Effects of Disclosure: An Experimental Investigation

Abstract

This paper examines experimentally the sequential equilibrium theory of reputation and disclosure developed in Lunawat, 2009. It provides experimental evidence in support of the sequential equilibrium play and of the reputation building role played by disclosure. The said paper predicts higher investment in economies with disclosure as compared to those without. In testing this prediction, this paper introduces a two-stage experimental design which turns out also to be a contribution to experimental methodology. The two-stage design allows for construction of subject samples with uniform prior beliefs about a manager’s trustworthiness but different disclosure institutions. Data collected using this design provides support for the said prediction. This paper also sheds light on a related question of the reputation building role played by incremental disclosure. It introduces a multi-period setting that allows reinvestment of capital and provides for definition of incremental disclosure in an economy. It is shown that incremental disclosure results in even higher investment.