Disclosure‐Disciplining Mechanisms: Capital Markets, Product Markets, and Shareholder Litigation

This paper demonstrates that a firm's trade‐offs between reporting good news to reduce the cost of capital and bad news to minimize proprietary costs can induce the firm's manager to provide truthful disclosures when the opposing effects balance each other. We also show that greater proprietary costs can make a firm's disclosures more credible, increase the frequency of voluntary adverse disclosures, and improve the disclosing firm's welfare. Further, we find that potential shareholder litigation can interact with capital and product markets' influences to make voluntary disclosures more credible, but only under certain circumstances. For example, although product market competition can complement the capital market effects in inducing the manager to provide truthful disclosures, shareholder litigation cannot complement the capital market in the same way. Nevertheless, while shareholder litigation can never induce misreporting, a very strong product market influence can prompt a firm to underreport its tr...

[1]  Sanjay Kallapur,et al.  Securities Price Consequences of the Private Securities Litigation Reform Act of 1995 and Related Events , 2001 .

[2]  P. Sengupta,et al.  Corporate Disclosure Quality and the Cost of Debt , 1998 .

[3]  Douglas J. Skinner.  WHY FIRMS VOLUNTARILY DISCLOSE BAD-NEWS , 1994 .

[4]  Brett Trueman,et al.  Managerial Disclosures and Shareholder Litigation , 1997 .

[5]  Sanford J. Grossman.  The Informational Role of Warranties and Private Disclosure about Product Quality , 1981, The Journal of Law and Economics.

[6]  Marilyn F. Johnson,et al.  The Impact of Securities Litigation Reform on the Disclosure of Forward-Looking Information by High Technology Firms , 2001 .

[7]  Gordon D. Richardson,et al.  The Voluntary Inclusion of Forecasts in the MD&A Section of Annual Reports , 1994 .

[8]  Robert A. Korajczyk,et al.  The Effect of Information Releases on the Pricing and Timing of Equity Issues , 1991 .

[9]  Frank Gigler,et al.  Self-Enforcing Voluntary Disclosures , 1994 .

[10]  Chandra Kanodia.  Stochastic Monitoring and Moral Hazard , 1985 .

[11]  Alfred Wagenhofer,et al.  Voluntary disclosure with a strategic opponent , 1990 .

[12]  J. Alexander.  Do the Merits Matter? A Study of Settlements in Securities Class Actions , 1991 .

[13]  Maureen F. McNichols,et al.  Discretionary Disclosure and External Financing , 1995 .

[14]  Christine Botosan.  Disclosure level and the cost of equity capital , 1997 .

[15]  Joel S. Demski,et al.  Economically Optimal Performance Evaluation And Control-Systems , 1980 .

[16]  Baruch Lev,et al.  To warn or not to warn: Management disclosures in the face of an earnings surprise , 1995 .

[17]  J. Francis,et al.  SHAREHOLDER LITIGATION AND CORPORATE DISCLOSURES , 1994 .

[18]  David M. Kreps,et al.  Signaling Games and Stable Equilibria , 1987 .

[19]  Marilyn F. Johnson,et al.  Shareholder Wealth Effects of the Private Securities Litigation Reform Act of 1995 , 2000 .

[20]  Richard C. Sansing,et al.  Disclosure Policies With Multiple Users , 1993 .

[21]  Paul R. Milgrom,et al.  Good News and Bad News: Representation Theorems and Applications , 1981 .

[22]  John M. Hassell,et al.  The Effect of Legal Environment on Voluntary Disclosure: Evidence from Management Earnings Forecasts Issued in U.S. and Canadian Markets , 2002 .

[23]  Linda Smith Bamber,et al.  Discretionary management earnings forecast disclosures: Antecedents and outcomes associated with forecast venue and forecast specificity choices , 1998 .

[24]  R. Posner,et al.  Economic Analysis of Law , 1974 .

[25]  Robert E. Verrecchia.  Information quality and discretionary disclosure , 1990 .

[26]  R. Gibbons,et al.  Cheap Talk with Two Audiences , 1989 .

[27]  Robert Gibbons,et al.  Simultaneous signalling to the capital and product markets , 1987 .

[28]  Gerald A. Feltham,et al.  Voluntary financial disclosure in an entry game with continua of types , 1992 .

[29]  Yong‐Chul Shin.  The Effect of Product Market Competition on Corporate Voluntary Disclosure Decisions , 2002 .

[30]  R. Dye.  DISCLOSURE OF NONPROPRIETARY INFORMATION , 1985 .