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Voluntary disclosure under dynamic moral hazard

Author

Listed:
  • Shiming Fu

    (University of Rochester)

  • Giulio Trigilia

    (University of Rochester)

Abstract

We introduce voluntary disclosure in a dynamic agency model with non-verifiable cash flows. Evidence reduces the use of high powered cash incentives, and the optimal contract features ``pay for verifiable bad luck''. The firm solvency and liquidity dynamics can be implemented by long-term debt, equity, and a credit line with interest rate contingent on both the disclosed evidence and the reported cash flow. Against the conventional wisdom, more frequent expected disclosure might lower firm value ex ante. As more evidence becomes available, two countervailing forces shape the solvency and liquidity dynamics: while firm value becomes more persistent after disclosure of bad news, the firm faces higher interest rate charges both in low states (absent disclosure), and when cash flows are high. For low profitability firms, the two effects must induce a non-monotonicity in firm value: more widespread evidence leads to less firms surviving in the long run.

Suggested Citation

  • Shiming Fu & Giulio Trigilia, 2018. "Voluntary disclosure under dynamic moral hazard," 2018 Meeting Papers 448, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:448
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    References listed on IDEAS

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