Renegotiation-Proof Contracting, Disclosure, and Incentives for Efficient Investment
University of Texas at Dallas - Naveen Jindal School of Management
Indiana University - Kelley School of Business - Department of Finance
Philip H. Dybvig
Washington University in Saint Louis - John M. Olin Business School
June 13, 2007
AFA 2006 Boston Meetings
Disclosure by firms would seem to reduce the informational asymmetry that is a cause of investment inefficiency in firms. However, the effect of disclosure is subtle, especially when the link between disclosure and firm value is endogenous and depends on incentives within the firm. We analyze various disclosure regimes and determine which ones are effective in a model with optimal renegotiation-proof contracts. Disclosing only accepted contracts is not effective, but either full transparency of all compensation negotiations or, more reasonably, additional disclosure of a forward-looking announcement is effective. The model is robust to renegotiation in equilibrium and is also robust to changing who offers any renegotiation. The analysis illuminates optimal disclosure regulation. For example, it tells us that allowing forward-looking disclosure is beneficial provided we are in an environment that produces the optimal contract, which gives the manager an incentive for truth-telling.
Number of Pages in PDF File: 34
Keywords: Investment efficiency, compensation disclosure, earnings forecasts, optimal contracting, renegotiation-proofness
JEL Classification: G38, M41, M52
Date posted: February 3, 2005
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