Strategic Disclosure as an Explanation for Asymmetric Return Volatility

Abstract

Strategic disclosure, which we define as the reporting of good news and the withholding of bad news, provides an explanation for a well-documented dynamic pattern in returns: The negative relation between return shocks and conditional return volatility. Black (1976) dubbed this relation the "leverage effect." With strategic reporting, positive share price responses in the event of good news result from news arrival. Negative share price responses, in contrast, are more likely due to an inference of bad news, which implies a smaller reduction in residual uncertainty. We document that the leverage effect is stronger in the return series of individual firms that are more likely to disclose strategically as measured by their litigation risk incentives. Patterns in returns/return volatility in market indices also are consistent with strategic disclosure as an explanation. These analyses are an important component of the study because they indicate that strategic disclosure decisions by individual firms are strong enough not only to create patterns in their own stock returns, but also that they may be powerful enough to explain market-wide patterns despite the covariance effects of aggregation of disclosure behavior over multiple firms.

Keywords: Strategic disclosure, bad news, disclosure thresholds, leverage effect

JEL Classification: G12, G30, M41, M45