Why Do Firms Gravitate to Selective Disclosure?

Abstract

In this paper, we build on a rational expectation model to study the economic consequences of a firm's choice of disclosure audience in a market with heterogenous traders in terms of information processing abilities. Through costly expertise acquisition, some traders become sophisticated and can better process the information disclosed by the firm. In contrast to the common view that selective disclosure negatively impacts the market by allowing certain groups of investors to make profit from superior information, we show that, when the expertise acquisition is endogenous, price informativeness under selective disclosure is always higher than that in the public disclosure regime. The reason is that selective disclosure promotes the ex ante expertise acquisition among traders, and thereby improves the aggregate information quality impounded into the price. Moreover, the market liquidity and the welfare of traders may also be higher under selective disclosure, especially when the firm's information is noisy and the ability to process information matters the most to make the inference about the fundamentals.