Renegotiation-Proof Contracting, Disclosure, and Incentives for Efficient Investment

Abstract

Disclosure by firms would seem to reduce the informational asymmetry that is a cause of investment inefficiency in firms. However, the effect of disclosure is subtle, especially when the link between disclosure and firm value is endogenous and depends on incentives within the firm. We analyze various disclosure regimes and determine which ones are effective in a model with optimal renegotiation-proof contracts. Disclosing only accepted contracts is not effective, but either full transparency of all compensation negotiations or, more reasonably, additional disclosure of a forward-looking announcement is effective. The model is robust to renegotiation in equilibrium and is also robust to changing who offers any renegotiation. The analysis illuminates optimal disclosure regulation. For example, it tells us that allowing forward-looking disclosure is beneficial provided we are in an environment that produces the optimal contract, which gives the manager an incentive for truth-telling.

Keywords: Investment efficiency, compensation disclosure, earnings forecasts, optimal contracting, renegotiation-proofness

JEL Classification: G38, M41, M52