Voluntary Disclosure of Firms as a Function of Industry Correlation: An Experimental Study

Voluntary Disclosure of Firms as a Function of Industry Correlation: An Experimental Study Gabriel D. Rosenberg

Motivation • U.S. securities markets are based mainly on mandatory disclosure. • Mandatory disclosure is expensive – will voluntary disclosure work just as well? • Are there different circumstances under which we need mandatory vs. voluntary disclosure?

Different Industries • Firms are not all the same. Firms in the same industry may have a common component to their value – correlation between firms in an industry. • “Disclosures by one firm in an industry may alter investors’ beliefs about the profitability of other firms in the same industry, and thereby change their market value.” (Dye, citing Foster)

Question • Do firms’ voluntary disclosure choices change as the correlation between firm values change?

Hypotheses • Public goods hypothesis: • “Voluntary disclosure will necessarily be incomplete, will not be as informative as it potentially could be, and might be very wasteful. Disclosure involves information, which is a free good and is difficult for those who produce it to capture the full gain from the cost of disclosure (public good). Thus, there is underproduction of information. There is a free-rider effect for similar companies.” [paraphrasing Judge Ralph Winter, Yale Law School class on Securities Regulation] • Alternatively, disclosure decision might just be based on value.

Experimental Method • Common Weighting % randomly chosen • Value = (Common Weighting %)*(Common Component) + (100–Common Weighting %)*(Individual Component) • Firms decide whether to disclose (cost of 10) • Investors bid on firms

Total Disclosures

Disclosure as a Function of Value

Disclosure as a Function of CommonValue

Disclosure as a Function of Independent Value

Logit Model • Used to predict a binary event Pr(DisclosureChoice = 1|Var1, Var2, Var3 …) = f(β0 + β1Var1 + β2Var2 + β3Var3 …)

Logit Model: Disclosure Choice as a Function of Value

Logit Model: Disclosure Choice as a Function of Correlation, CommonValue, and IndependentValue

Logit Model: Disclosure Choice as a Function of the Components Value

Conclusion • Firms seem to make decision based on value (mainly independent value) rather than correlation • No visible public goods problem • In the future, would be better to pick certain correlation levels and randomize within those rather than completely random

Voluntary Disclosure of Firms as a Function of Industry Correlation: An Experimental Study