Firm Disclosures and Investors’ Capital Rationing Incentives
50 Pages Posted: 28 Mar 2022 Last revised: 16 May 2023
Date Written: December 8, 2022
This paper analyzes firm disclosures and associated consequences in an entrepreneurial financing setting. We construct a model where two entrepreneurs compete for a private equity investor's capital and use disclosure to influence the investor's belief. We show that disclosure in such markets increases firms' real investment in productive activities, but may also result in capital rationing by the investor. This finding contrasts with the conventional wisdom that disclosure alleviates information asymmetry and improves firms' access to external capital. When the investor allocates capital based on firms' disclosures, a disclosure contest results and firms increase their productive investment to enhance the disclosure outcomes. We show that such a disclosure contest can result in over-investment and that equity investors can limit over-investment by reducing the amount of capital that they make available to the firms. Consequently, more disclosure in private equity markets may reduce firms' access to equity capital.
Keywords: Disclosure, Real Investment, Competition for Capital, Capital Rationing
JEL Classification: M40, M41
Suggested Citation: Suggested Citation