Strategic Misrepresentation of Information : Implications of Biased and Diverse Information in Capital Markets

Today's predominant disclosure philosophy calls for the fulldisclosure of all decision relevant information bycompanies. More publicly available information, theargument goes, limits the adverse selection problem by reducinginformation asymmetry among heterogeneous investors. Thus, theliquidity in capital markets will be increased and the cost ofcapital decreased in consequence, to the benefit of all.But is more disclosure really always preferable? Two arguments canbe brought forward which shed a different light on the above line ofargument. Firstly, decision relevant information necessarilyinvolves future-oriented, manipulable information. Secondly,supposing that information processing skills differ among investors,a disclosure may inherently create information asymmetries insteadof relieving them.In such a scenario, it becomes important to know who generatesinformation (and with which incentives), how that information isdisseminated in capital markets and incorporated into market pricesand finally, whether the overall effect of such releases ofinformation is to level the informational playing field or viceversa. If a disclosure does not make the playing field more leveled,it also becomes unclear what the economic purpose of disclosurereally is.The following formal analysis investigates four alternative marketsettings which simultaneously include a manager's incentivesregarding the share price of his firm on the one hand and a group ofheterogeneously informed common-stock investors on the other hand.This allows us to calculate a number of market characteristics andto identify scenarios under which more disclosure is preferable andothers under which it is not.