Asymmetric Disclosure, Noise Trade, and Firm Valuation

Abstract

We study the impact of asymmetric (i.e., conservative or aggressive) disclosure on a firm's price in the classic setting in which its stock is traded by risk-averse investors and noise or liquidity traders. We show that asymmetric accounting policies alter the relative risk faced by investors when they short vs. long, which causes market liquidity to differ for positive vs. negative demand shocks. As a result, accounting conservatism raises firms' valuations and lowers their expected returns. We further demonstrate that the relationship between accounting informativeness and expected returns depends upon the skewness of investors' prior beliefs. Finally, we find that a firm that can commit to an accounting policy can tailor this policy to benefit from noise trade and foster overvaluation.

Keywords: Short-selling, Noise Trade, Disclosure, Bayesian Persuasion, Downside Risk, Trading

JEL Classification: D72, D82, D83, G20