Word of Mouth, Noise-Driven Volatility, and Public Disclosure
54 Pages Posted: 27 Dec 2018 Last revised: 8 Feb 2019
Date Written: October 9, 2018
This paper examines how a firm's information environment is affected by technological innovations that enhance investors' private information. We show that refining investors' private information imposes an endogenous cost of amplifying supply shocks and increasing price volatility. We also examine how the firm reacts to such changes. We derive a necessary and sufficient condition under which the firm improves its disclosure quality when its investors are informed with better private signals. The analysis indicates a "dark side" of investors' word-of-mouth communications even when the communications are assumed to be unbiased and truthful. We generate empirical predictions regarding how market depth, volatility, and firms' disclosure qualities would change as technological innovations, such as social media, facilitate investors' private communications.
Keywords: Public Disclosure, Private Word of Mouth, Price Volatility
JEL Classification: D82, G14, M41
Suggested Citation: Suggested Citation