Voluntary disclosure under dynamic moral hazard

Abstract

We study a dynamic moral hazard setting where the manager has private ev- idence that predicts the firm's cash flows. When performance is low, bad news disclosure is rewarded by a lower borrowing cost relative to the no-evidence case. In contrast, no disclosure is associated with higher borrowing costs. On net, disclo- sure weakens the relation between cash incentives (or stock values) and short-term performance, which lowers the firm’s default risk on path. However, the expecta- tion of future disclosure might increase the optimal initial level of debt, to a point where the firm’s default risk actually rises relative to the no-evidence case.