Optimal Reporting Systems with Investor Information Acquisition

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2022
Authors
Huang, Zeqiong
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This paper analyzes the optimal design of a firm’s ex-ante reporting system when the reporting system affects investors’ information acquisition decisions. In my model, investors’ information acquisition (costly inspection) affects their willingness to finance the firm’s investment project, which in turn affects the firm manager’s payoff. I analyze how the informativeness and bias of a firm’s optimal reporting system depend on the market’s prior belief about the project profitability, the investors’ inspection cost, and the degree of incentive alignment between manager and investor. A mis-aligned manager’s system is informative only when the common prior is pessimistic, and the system is always positively biased, but less so when the investor’s inspection cost decreases. In contrast, a well-aligned manager’s system is counter-cyclical to the market belief when the inspection cost is low: it is positively (negatively) biased when the market belief is pessimistic (optimistic). I also analyze how the properties of the optimal reporting system are related to investment efficiency, and explore the extent to which the results generalize to a case with managerial manipulation. Overall, the analysis describes the complex interactions among determinants of firm disclosures, and offers explanations for the empirical results in this area and provides new predictions.
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Information Acquisition, Optimal Reporting Systems, Earnings Manipulation, Incentive Alignment, Bias and Informativeness
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