Voluntary Disclosure, Manipulation and Real Effects

Abstract

We study a model in which managers' disclosure and investment decisions are both endogenous and managers can manipulate their voluntary reports through (suboptimal) investment, financing or operating decisions. Managers are privately informed about the value of their firm and have incentives to voluntarily disclose information and manipulate their reports in order to obtain more favorable terms when issuing equity to finance a new profitable investment opportunity.

The model shows that treating managers' disclosure and investment decisions both as endogenous and allowing managers to manipulate their voluntary reports yields qualitatively different predictions than when the disclosure and investment decisions are considered separately and managers cannot engage in manipulation. The model predicts that managers' disclosure strategy is sometimes characterized by two distinct non-disclosure intervals (contrary to traditional threshold equilibria of voluntary disclosure models) and that managers with intermediate news sometimes forego the new profitable investment opportunity (in contrast to Myers and Majluf 1984). As such, the paper highlights the importance of considering the interdependencies between firms' disclosure and investment decisions and provides new empirical predictions.

Keywords: Voluntary disclosure, earnings management, investment decisions, cost of capital

JEL Classification: M43