“ Idiosyncratic Risk , Systematic Risk , and Firm Welfare ”

We study the motivation of an entrepreneur to provide disclosure that works primarily to reduce investors’assessment of the firm’s idiosyncratic risk. We refer to this disclosure as “idiosyncratic disclosure.”We assume that the firm’s cash flows are determined by both idiosyncratic and systematic events. The model shows that when the entrepreneur faces a capital market where competition to acquire firm’s shares is imperfect, he trades off the reduction in investors’assessment of the firm’s idiosyncratic risk against the reduction in liquidity as a result of increased competitiveness among investors who trade in the firm’s shares. In other words, a reduction in idiosyncratic risk yields countervailing effects. This result contrasts with the one in Lambert, Leuz, and Verrecchia (2007) that shows that a firm benefits unambiguously from disclosure that reduces investors’assessment of systematic risk: in effect, “systematic disclosure.” We thank seminar participants at UCLA and, specifically, Judson Caskey for insightful comments.