Why do Firms Gravitate to Selective Disclosure?

In this paper, we present a theoretical model to explain why firms gravitate to selective disclosure. We consider a setting where a firm chooses its disclosure policy to maximize its price informativeness (i.e., how much information is impounded in the price, measured by the posterior precision of true value conditional on the price) in a market with different types of traders. Through ex-ante acquisition of expertise, traders become sophisticated and improve their ability to better interpret the information disclosed by the firm. We show that firms sometimes prefer to disclose information selectively, providing information only to sophisticated traders, rather than to the public. The primary reason is that selective disclosure promotes the ex-ante expertise acquisition among traders. Consequently, under selective disclosure, the aggregate information quality is overall higher and prices are more informative than under public disclosure. However, selective disclosure may reduce uninformed investor welfare. ∗The previous version of the paper is titled “An Analytical Investigation of Economic Consequences of Regulation Fair Disclosure”. Bjorn is from University of Colorado at Boulder, Jing is from Carnegie Mellon University, and Nahum is from Columbia University, e-mail: [email protected], jlill@@andrew.cmu.edu, and [email protected]. We would like to thank Shira Cohen, Carlos Corona, Jon Glover, Pierre Liang, Lin Nan, John O’Brien, Jack Stecher and seminar participants at Carnegie Mellon University, University of Colorado for helpful comments on our paper. We thank Ran Zhao for research assistance. All errors are our own.