Strategic Communication With A Myopically Loss Averse Investor

Abstract

We develop a multi-period communication model in which a manager knows the firm's fundamental value before the firm's myopically loss averse investor. The manager may disclose truthfully or provide strategically biased information to influence the investor's evaluation of firm performance. The optimal managerial communication strategy is to report firm values as close to prior market values as possible. This strategy reduces disproportionately painful downward price movements, alleviates stock price volatility, and generates stock price momentum. We empirically support the model's predictions with respect to the interplay between biased managerial communication and stock returns.

Keywords: Strategic Information Transmission, Myopic Loss Aversion, Behavioral Economics, Disclosure, Momentum

JEL Classification: D91, G41