Partial Disclosure Equilibrium Research Articles

Score Disclosure

Abstract We study verifiable disclosure by a seller when the product has multiple quality attributes. We identify an equilibrium in which, for some qualities, the seller discloses its score—the average of the qualities—and does not reveal anything else. This occurs when its score is sufficiently high or when the qualities are sufficiently similar and the score is not too low. Otherwise, the seller fully discloses. While full unraveling is still an equilibrium, it is dominated by this partial score disclosure equilibrium in terms of ex ante as well as ex post profits.

On Market Concentration and Disclosure

ABSTRACT Verrecchia (1983, 1990) introduced the proprietary cost hypothesis in which exogenous disclosure costs are a reduced-form interpretation of lost competitive advantage in product markets. We develop a micro-foundation for this disclosure cost in a Cournot game and explicitly derive the cost as a function of market structure. When the market is sufficiently competitive, this model has a reduced-form representation similar to a standard voluntary disclosure game with a partial disclosure equilibrium. Proprietary costs are increasing in the number of competitors, the degree of product substitution, overall uncertainty, and production costs. The analysis also offers new empirical predictions on the interaction between disclosure choice, managerial horizon, and entry. JEL Classifications: D82; L13; L50; M23; M4.

Uncertainty about Managerial Horizon and Voluntary Disclosure

I examine the relation between investors’ uncertainty about managerial horizon and corporate voluntary disclosure. I argue that investors’ uncertainty about the manager’s short-term stock price concern works as a disclosure friction that allows for a partial disclosure equilibrium. When investors are uncertain about managers’ horizons, short-horizon managers can withhold bad news by pooling with long-horizon managers who are not motivated to disclose regardless of the content of the news, as they are largely indifferent to short-term stock prices. Based on this theoretical framework, I hypothesize that reducing investors’ uncertainty about managerial horizon reduces this disclosure friction, thereby pressuring short-horizon managers to provide more voluntary disclosure. I use the executive compensation disclosure mandate as an empirical setting that reduced investors’ uncertainty about managerial horizon. Employing a difference-in-differences research design, I find a significant increase in voluntary disclosure for treated firms relative to control firms, largely driven by firms with short-horizon managers.

Disclosure of Managerial Contract Information in a Vertically Related Market

The observability of managerial contract information in duopolies with strategic delegation has been an issue of controversial discussion. In a recent paper, Baik and Lee (2019) endogenize the decision to disclose the details of managerial contracts and show that in equilibrium, the owners of both firms have an incentive to always voluntarily reveal contract information, independent if firms compete in quantities or prices. We study how voluntary disclosure of contract information is affected by the presence of a supplier that provides an input to both firms. We demonstrate that under quantity competition, a partial disclosure equilibrium may occur if product differentiation is low. Disclosing firms punish their managers for sales to soften supplier pricing. Mandating disclosure increases total welfare, but consumer surplus decreases. Under price competition, firms always want to disclose. Finally, firm profits can be higher under price competition than under quantity competition.

On Market Concentration and Disclosure

Verrecchia (1983, 1990) introduced the proprietary cost hypothesis in which exogenous disclosure costs are a reduced-form interpretation of lost competitive advantage in product markets. We develop a micro-foundation for this disclosure cost in a Cournot game and explicitly derive the cost as a function of market structure. When the market is sufficiently competitive, this model has a reduced-form representation similar to a standard voluntary disclosure game with a partial disclosure equilibrium. Proprietary costs are increasing in the number of competitors, the degree of product substitution, overall uncertainty and production costs. The analysis also offers new empirical predictions on the interaction between disclosure choice, managerial horizon and entry.

Misreporting and Regulatory Incentives

I study how regulators' self-interest affects the transparency of their enforcement regimes and, as a result, misreporting by overseen firms. I use the revolving door from government to the private sector as a natural, commonly-occurring setting that captures self-interest. In this setting I construct a model in which the regulator's desire to revolve or not, as well as the intensity of regulatory enforcement, is private information that the regulator can voluntarily disclose. Uncertainty about the regulator's incentives and regulatory intensity yields a nontrivial partial disclosure equilibrium in which, despite the presence of the revolving door, selective disclosure can lead to lower levels of misreporting. The model provides a lens through which to understand recent empirical work on how regulators with private-sector ambitions behave, and suggests avenues for future empirical research.

Voluntary disclosure and strategic stock repurchases

We study the choice of disclosure and share repurchase strategies of informed managers using a model that captures how they differentially impact short and long-term stock value. We identify a partial disclosure equilibrium in which firms in the lowest value region neither disclose nor repurchase, firms with intermediate values disclose but do not repurchase, and firms in the highest value region induce undervaluation by not disclosing and buy back shares. In particular, the well known unraveling result when the manager is always informed (and when disclosure is costless)—the typical upper-tailed disclosure region in classic voluntary disclosure models—need not obtain when informed managers can use repurchases to extract information rents. We offer a new perspective on open-market share repurchases—the most common form of share repurchases—when chosen optimally with disclosure. Our analysis indicates that the equilibrium disclosure region shrinks as the firm's stock trading liquidity increases.

Time to Come Clean? Disclosure and Inspection Policies for Green Production

We examine the interplay between two important decisions that impact environmental performance in a production setting: inspections performed by a regulator and noncompliance disclosure by a production firm. To preempt the penalty that will be levied once a compliance violation is discovered in an inspection, the firm dynamically decides whether it should disclose a random occurrence of noncompliance. Anticipating this, the regulator determines inspection frequency and penalty amounts to minimize environmental and social costs, performing either random inspections or periodic inspections. We study this problem by developing a novel analytical framework that combines features from reliability theory and law enforcement economics. We find that, contrary to common belief, surprising the firm with random inspections is not always preferred to inspecting the firm periodically according to a set schedule. We also find that the firm’s opportunistic disclosure timing behavior may lead to a partial disclosure equilibrium in which the substitutable relationship between inspection intensity and penalty is reversed; a threat of increased penalty is accompanied by more frequent inspections.

Discretionary disclosure, spillovers, and competition

We present a differentiated duopoly model, in which an industry leader’s disclosure of innovations achieved through research and development (R&D) activities reveals efficiency gains and enables a rival to free ride. Competitive intensity is measured by the degree of product substitutability. A tension arises between the incentive to influence the rival’s pricing or output decision by sharing information on R&D innovations and the incentive to avoid knowledge spillovers that allow the rival to also benefit. We show that either no or partial disclosure equilibrium prevails. In contrast to a commonly held view of an inverse relation between competition and disclosure, we identify conditions on knowledge spillovers, under which more disclosure transpires in equilibrium as competition intensifies. This result holds, irrespective of whether firms engage in price or quantity competition. We also show that a more innovative technology leads to more (less) disclosure in the case of price (quantity) competition.

Shareholder litigation, management forecasts, and productive decisions during the initial public offerings

This paper develops a model to analyze the impact of shareholder litigation on managers’ voluntary disclosure strategies in equity offerings. The major findings are as follows. First, under different economic parameters, the entrepreneur has two possible equilibrium disclosure strategies: full and partial disclosure. Of particular interest is the latter equilibrium, in which shareholder litigation can give the entrepreneur incentives to partially disclose her private information. Second, production decisions might be distorted by the entrepreneur’s disclosure incentives. The full disclosure equilibrium is associated with underinvestment, while overinvestment exists in the partial disclosure equilibrium. The model is then used to examine the effect of regulatory polices on firms’ disclosure incentives. It shows that relaxing the legal liability can result in more information flow to the public. However, it also leads to a higher rate of lawsuits and an increase in deadweight litigation costs.

Voluntary disclosure of information when firms are uncertain of investor response

A firm may prefer not to disclose its private information if it is uncertain of investor response. In the setting under consideration, a firm needs to acquire capital from an investor. The investor can choose to invest in the firm, the risk free asset or in some alternative risky investment opportunity. It is shown that in a partial disclosure equilibrium, the firm discloses average information and withholds bad and good information. Disclosure of average information arises to attract the investor's capital away from the risk free asset.

Discretionary Risk Disclosures

We model managers' equilibrium strategies for voluntarily disclosing information about their firm's risk. We consider a multifirm setting in which the variance of each firm's future cash flow is uncertain. A manager can disclose, at a cost, this variance before offering the firm for sale in a competitive stock market with risk-averse investors. In our partial disclosure equilibrium, managers voluntarily disclose if their firm has a low variance of future cash flows, but withhold the information if their firm has highly variable future cash flows. We establish how the manager's discretionary risk disclosure affects the firm's share price, expected stock returns, and beta, within the framework of the Capital Asset Pricing Model. We show that whereas one manager's discretionary disclosure of his firm's risk does not affect other firms' share prices, it does affect the other firms' betas. Also, we demonstrate that a disclosing firm has lower risk premium and beta ex post than a nondisclosing firm. Finally, we show that ex ante, the expected risk premium and expected beta of each firm are higher under a mandatory risk disclosure regime than in the partial disclosure equilibrium that arises under a voluntary disclosure regime.

The Sale of Ideas: Strategic Disclosure, Property Rights, and Contracting

Ideas are difficult to sell when buyers cannot assess an idea's value before it is revealed and sellers cannot protect a revealed idea. These problems exist in a variety of intellectual property sales ranging from pure ideas to poorly protected inventions and reflect the nonverifiability of key elements of an intellectual property sale. An expropriable partial disclosure can be used as a signal, allowing the seller to obtain payment based on the value of the remaining (undisclosed) know-how. We examine contracting after the disclosure and find that seller wealth is pivotal in supporting a partial disclosure equilibrium and in determining the payoff size.

Insider trading and the voluntary disclosure of information by firms

We examine the voluntary disclosure policy of a firm where the manager has private information and opportunities to trade on it. The equilibrium disclosure policy ranges from full disclosure to partial disclosure to nondisclosure depending on whether the manager's pay–performance sensitivity is high, medium or low, respectively. In the partial disclosure equilibrium, good news is more likely to be disclosed early than bad news and insiders are more likely to sell than buy shares, two results for which there is ample empirical support. The likelihood and amount of voluntary disclosure increases with the manager's pay–performance sensitivity, firm quality, and the number of insiders privy to the information and decreases with market liquidity. Stringent enforcement of insider trading regulations induces more disclosure by firms whereas the short sales prohibition on insiders induces less disclosure.

Acquisition and Discretionary Disclosure of Private Information and Its Implications for Firms' Productive Activities

It is well known in the literature (e.g., Dye [1985] and Jung and Kwon [1988]) that when outside investors are unsure of the information endowment of a firm's manager (whose objective is to maximize the firm's current market price), a partial disclosure equilibrium prevails. In particular, a manager who has a private signal about the firm's future value discloses the signal if, and only if, it exceeds a cutoff value. This is in contrast with a full disclosure equilibrium, which would prevail if investors are sure the manager possesses private information (see Grossman [1981] and Milgrom [1981]). The objective of this study is to examine the implications of discretionary disclosure for a firm's production efficiency when acquiring private information is costly.' In other words, we ask, Why and how are a firm's

Corporate Disclosure of Environmental Liability Information: Theory and Evidence*

Abstract. The decision to disclose information concerning a firm's environmental liabilities is modeled as a sequential game involving the firm, a capital market, and outside stakeholders who can impose proprietary (political) costs on the firm. A partial disclosure equilibrium is derived in which firms reveal information strategically, maximizing the share‐value net of expected political costs. Inherent uncertainty regarding the existence and size of the liabilities creates a setting where outsiders are uncertain if management is informed about these liabilities, so firms can plausibly withhold “bad news”, that is, they do not disclose liabilities that exceed a threshold level. Three novel hypotheses are that a firm is more likely to disclose as (1) its pollution propensity increases, (2) outsiders' knowledge of its environmental liabilities increases, and (3) the risk of incurring proprietary costs decreases. Empirical support is found for the hypotheses, based on the accounting disclosures made by sample firms selected from the records of the Ontario Ministry of the Environment and Energy.Improved accounting and auditing standards for environmental disclosure would build on at least three implications of the study: To the extent that inherent uncertainty leaves managers with discretion as to what to disclose, the partial disclosure equilibrium result suggests that not all firms will comply with disclosure standards. Publishing broad environmental performance indicators for companies in nonaccounting outlets would increase public awareness of a manager's private information endowment, making voluntary accounting disclosures of the liabilities more likely. If a significant decline in stakeholder tolerance of pollution occurs, the expected proprietary costs of disclosing increase, and companies become less likely to disclose.

Experimental tests of disclosure with an opponent

This paper presents the results of 32 experimental markets designed to test hypotheses based on Wagenhofer's (1990) disclosure model. The model predicts the existence of multiple disclosure equilibria in cases where a manager balances the effects that disclosures can have on two sets of external agents: investors and an opponent. The experimental results support the partial-disclosure equilibrium over the full-disclosure option. Additionally, a lower level of disclosure was observed in those markets in which the discloser repeatedly interacted with information receivers. Lower disclosure reduces the level of proprietary costs which is beneficial to the information sender.