The Effect of Voluntary Disclosure on Investment Inefficiency

Abstract

Firms' ability to voluntarily disclose or conceal information may affect their investment decisions. In particular, voluntary disclosure in the presence of uncertainty about information endowment (a la Dye 1985) induces firms to choose the riskier among projects with equal expected returns (Ben-Porath et al. 2017). We study multi-stage investment decisions in which the firm's manager first chooses between projects with different riskiness and later may privately learn additional information about the technology of the chosen project. If informed, the firm can voluntarily disclose the new information to the market. Finally, based on the available information the manager determines the scale of the investment. If uninformed, the manager cannot tailor the investment scale to the realized technology. The resulting decrease in expected cash flow is higher for a riskier project. We study how a manager, who cares about both the firm's stock price (myopic incentive) and the long-term cash flow, optimally chooses the project and the voluntary disclosure decision, and how the investment efficiency varies with managerial myopia and information environment. As expected, managerial myopia always (weakly) decreases overall investment efficiency. However, information environment (the probability of obtaining information) may have a non-monotonic effect on overall investment efficiency. We extend the base model to allow for costly information acquisition and show that main results still hold.