A Theory of Two-Dimensional Communication: Welfare and Corporate Governance
88 Pages Posted: 10 Jan 2019
Date Written: November 2018
This paper studies when introducing verifiable information communication choices between managers, with social tie, is beneficial to shareholders. In our model managers have two ways to communicate their private information: either through a costly verifiable information (hard) link or through a low-cost cheap talk (soft) link. We identify that the appearance of hard links in the pure cheap talk setting has two opposing effects on welfare (shareholder value): (i) a positive effect stems from the information improvement and (ii) a negative effect arises from crowding out soft communication with costly verifiable communication. Surprisingly, the final welfare outcome of the two opposing forces depends on the cost structure. If only one party bears the cost of a hard link, then the positive (informational) effect always dominates the negative (crowding out) effect, and thus introducing hard links is beneficial to welfare. In contrast, if the cost of a hard link is shared by both parties, then allowing for verifiable communication can be detrimental to welfare. We also derive several testable implications about introducing hard links in corporate governance, and demonstrate the robustness of our findings in face of heterogenous costs, general signal structures, as well as the case where cost is endogenizied via negotiation about how to split the costs.
Keywords: Hard and Soft Communication, Welfare, Shareholder Value, Incentive, Networks, Corporate Governance
JEL Classification: D71, D72, D82, D83, G34
Suggested Citation: Suggested Citation