Forcing Firms to Talk: Financial Disclosure Regulation and Externalities

We analyze a model of voluntary disclosure by firms in financial market and the desirability of disclosure regulation. In our model firms choose the precision of their disclosure. Disclosure is costly and has private and social value. First we uncover convexities in the value of disclosure, which lead to discontinuities in the optimal disclosure policy as parameters change. We then show that with multiple firms whose values are correlated, the Nash equilibrium is often socially inefficient. This occurs because the disclosure by each firm affects the valuation of others. We study regulation that requires a minimal precision level, and also the use of subsides that change the perceived cost of disclosures. While both methods can sometimes improve welfare, neither dominates, and for each method there are cases where welfare is not improved if firms must be treated symmetrically.

Anat R. Admati and Paul Pfleiderer

Stanford University Graduate School of Business

January 1999

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