32 Pages Posted: 8 Mar 2011 Last revised: 21 Feb 2012
Date Written: September 1, 2011
Trading in a secondary stock market not only redistributes wealth among investors but also generates information that guides subsequent investment. We provide a positive theory of disclosure that reflects both functions of a secondary market. By making private information public, disclosure reduces private information acquisition and levels the playing field. However, a leveled playing field has two opposite effects on firm value. On one hand, it ameliorates adverse selection among investors and improves the liquidity of firm shares. On the other hand, it could also impede investment efficiency because less information is produced by the market and used by decision makers. This trade-off determines the optimal disclosure policy. Our theory generates new testable predictions and reconciles disclosure with other parts of securities regulation that encourage private information production.
Keywords: Disclosure, Securities Regulation, Adverse Selection, Informational Feedback Effect
JEL Classification: G14, K22, M41, M45
Suggested Citation: Suggested Citation
Gao, Pingyang and Liang, Pierre Jinghong, Informational Feedback Effect, Adverse Selection, and the Optimal Disclosure Policy (September 1, 2011). Chicago Booth Research Paper No. 11-13. Available at SSRN: https://ssrn.com/abstract=1780462 or http://dx.doi.org/10.2139/ssrn.1780462