Investor Sophistication and Disclosure Clienteles

Abstract

This paper explores the idea of disclosure clienteles. Disclosure clienteles refer to the ability of different types of disclosure activities to differentially benefit investors with varying levels of sophistication. Disclosure clienteles exist because variation in investor sophistication affects investors’ ability to utilize disclosed information, and thus their preferences for distinct disclosure activities. The paper utilizes cross-sectional variation in inefficient exercise activity in the options market to identify variation in sophistication (e.g., investors’ attention, knowledge, and expertise). The paper then presents empirical evidence consistent with disclosure clienteles. The results show that sophisticated investors concentrate their trading activity in firms that issue earnings guidance on a regular basis. This relation is stronger prior to RegFD, when sophisticated investors’ preferences for forecasting firms are predicted to be greater. Alternatively, less sophisticated investors are more prevalent in firms with increased levels of press-dissemination and superior investor relations activities (e.g., better access to information on the corporate website). These results suggest investors’ demand for disclosure is partially driven by their ability to utilize disclosed information.

Keywords: Investor sophistication, information processing costs, disclosure, information asymmetry, option exercise