Forcing Firms to Talk: Financial Disclosure Regulation and Externalities

43 Pages Posted: 31 Jul 1998

See all articles by Anat R. Admati

Anat R. Admati

Stanford Graduate School of Business

Paul C. Pfleiderer

Stanford Graduate School of Business

Date Written: April 1998

Abstract

In this paper we analyze a model of voluntary disclosure by firms in financial markets. We focus on externalities that arise when firm values are correlated and the disclosures made by one firm affect the valuation of other firms. In our model, firms can choose the precision of their disclosure, and disclosure, which is costly, has social value. In the case of one firm, we uncover interesting economies of scale in the value of the disclosure, which lead to discontinuities in the optimal disclosure policy as parameters of the model change. For example, the optimal precision may jump from zero to a positive level when the prior precision regarding the firm's value is at a threshold level. For the case of multiple firms, we show that because of the externality in the firms' valuation, the Nash equilibrium disclosure policies are often socially inefficient. Thus, there is scope for disclosure regulation to improve welfare. We study the possibilities of mandating a minimal precision level for the disclosure or setting a system of subsidies that reduce the perceived cost of disclosure. While both methods can sometimes improve welfare, for each method there are cases (where firms differ in their cost or other parameters) where welfare is not improved. Neither of these methods of regulation dominates the other in all situations.

JEL Classification: D6, G1, G2, G3, K2

Suggested Citation

Admati, Anat R. and Pfleiderer, Paul C., Forcing Firms to Talk: Financial Disclosure Regulation and Externalities (April 1998). Available at SSRN: https://ssrn.com/abstract=103968 or http://dx.doi.org/10.2139/ssrn.103968

Anat R. Admati

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
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Paul C. Pfleiderer (Contact Author)

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-723-4495 (Phone)
650-725-7979 (Fax)

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