Optimal Reporting Systems with Investor Information Acquisition

68 Pages Posted: 23 Jun 2016 Last revised: 29 Jul 2016

Date Written: July 1, 2016


This paper analyzes a manager’s optimal ex-ante reporting system using a Bayesian persuasion approach (Kamenica and Gentzkow (2011)) in a setting where investors affect cash flows through their decision to finance the firm’s investment opportunities, possibly assisted by the costly acquisition of additional information (inspection). I examine how the informativeness and the bias of the optimal system are determined by investors’ inspection cost, the degree of incentive alignment between the manager and investors, and the prior belief that the project is profitable. I find that a mis-aligned manager’s system is informative only when the market prior is pessimistic and is always positively biased. As investors’ inspection cost decreases, this bias decreases and the optimal system becomes more conservative. In contrast, a well-aligned manager’s system is fully revealing when investors’ inspection cost is high, and is counter-cyclical to the market belief when the inspection cost is low: It is positively (negatively) biased when the market belief is pessimistic (optimistic). I explore the extent to which the results generalize to a case with managerial manipulation and discuss the implications for investment efficiency. Overall, the analysis describes the complex interactions among determinants of firm disclosures and governance, and offers explanations for the mixed empirical results in this area.

Keywords: reporting system, information acquisition

JEL Classification: M41, G18, G31

Suggested Citation

Huang, Zeqiong, Optimal Reporting Systems with Investor Information Acquisition (July 1, 2016). Available at SSRN: https://ssrn.com/abstract=2799421 or http://dx.doi.org/10.2139/ssrn.2799421

Zeqiong Huang (Contact Author)

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

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