The Many Faces of Information Disclosure

We examine the effects of a variety of mandatory information disclosure regimes on the expected revenues of issuing firms and on their endogenously-arising incentives for financial innovation. The main question we ask is: what kind of information and how much of it should firms be asked to disclose? The analysis uses a noisy rational expectations model in which some investors can choose to become informed at their own expense. Information disclosure then potentially affects the information-advantage of these investors vis-a-vis uninformed (liquidity) investors in the market, and hence their information-acquisition incentives. Thus, asking managers to disclose more information is not obviously desirable for the shareholders of issuing firms. Our main results are as follows. Mandating the disclosure of information about total firm value that would otherwise not have become available to any investor is always good for issuing firms. It increases their expected revenues and also strengthens financial innovation incentives. Mandating the disclosure of information about total firm value that would have been acquired anyway by informed investors but improves the quality of the information that uninformed investors have will benefit firms in emerging capital markets but hurt those in developed capital markets. In developed markets, the attention devoted to disclosure should thus shift from information that concerns total firm value to that which concerns the distribution of this value among claimants. Our conclusion is that disclosure requirements should be more stringent in less-developed capital markets, and that greater stringency in disclosure requirements on securities exchanges leads to a worsening of the borrower pool faced by banks. Our analysis also implies that competition among exchanges or securities regulators will not necessarily lead to a weakening of disclosure requirements.