Why managers with low forecast precision select high disclosure intensity: an equilibrium analysis

Shin (J Account Res 44(2):351–379, 2006) has argued that in order to understand the equilibrium patterns of corporate disclosure, it is necessary for researchers to work within an asset pricing framework in which corporate disclosures are endogenously determined. Echoing this sentiment, Larcker and Rusticus (J Account Econ 49(3):186–205, 2010) have argued that earlier empirical results claiming to find a negative relationship between disclosure and cost of capital may suffer fatally from endogeneity issues which, once addressed by a formal structural model, may reverse the sign of the relationship. The purpose of this paper is to introduce a general equilibrium model following the Black–Scholes paradigm with endogeneous disclosure in which firms select uniquely determined optimal probabilities of early equity-value discovery in a noisy environment. As firms may differ also in the uncertainty (precision) with which management can forecast the future, managers strategically increase the intensity of their (voluntary) disclosures to provide partial compensation for this perceived differential risk. A positive relationship then results between disclosure and the cost of capital.