The Effect of Limited Liability on the Market Response to Disclosure
Posted: 19 Mar 1997
We formalize the effects of an earnings disclosure on security prices under an assumption of limited liability. We derive various non-linear relations between equity prices and earnings under a variety of capital structure assumptions and, if possible, tie the relations attained to results from the existing empirical literature. We also characterize how debt prices respond to earnings when holders of debt have limited liability. Finally, we analyze how changes in the degree of leverage and conversion features of debt affect the relation between price and earnings.
JEL Classification: M41, G12, K22, G32
Suggested Citation: Suggested Citation