Informational Feedback Effect, Adverse Selection, and the Optimal Disclosure Policy
University of Chicago - Booth School of Business
Pierre Jinghong Liang
Carnegie Mellon University - Tepper School of Business; CAFR/SAIF
September 1, 2011
Chicago Booth Research Paper No. 11-13
Trading in a secondary stock market not only redistributes wealth among investors but also generates information that guides subsequent investment. We provide a positive theory of disclosure that reflects both functions of a secondary market. By making private information public, disclosure reduces private information acquisition and levels the playing field. However, a leveled playing field has two opposite effects on firm value. On one hand, it ameliorates adverse selection among investors and improves the liquidity of firm shares. On the other hand, it could also impede investment efficiency because less information is produced by the market and used by decision makers. This trade-off determines the optimal disclosure policy. Our theory generates new testable predictions and reconciles disclosure with other parts of securities regulation that encourage private information production.
Number of Pages in PDF File: 32
Keywords: Disclosure, Securities Regulation, Adverse Selection, Informational Feedback Effect
JEL Classification: G14, K22, M41, M45
Date posted: March 8, 2011 ; Last revised: February 21, 2012
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