Informational feedback, adverse selection, and optimal disclosure policy

Abstract

Faceless trading in a secondary stock market not only redistributes wealth among investors but also generates information that feeds back to real decisions. Using this observation we re-evaluate the "leveling-the-playing-field" rationale for disclosure to secondary stock markets. By partially preempting traders' information advantage established from information acquisition, disclosure reduces private incentives to acquire information, resulting in two opposite effects on firm value. On one hand, this narrows the information gap between informed and uninformed traders and improves liquidity of firm shares. On the other hand, this reduces the informational feedback from the stock market to real decisions. This tradeoff determines the optimal disclosure policy. The model explains why firm value can be higher in an environment that simultaneously promotes disclosure and private information production and why growth firms are endogenously more opaque than value firms. ©, University of Chicago on behalf of the Accounting Research Center, 2013.