The Kind of Silence: Managing a Reputation for Voluntary Disclosure in Financial Markets

TL;DR

This paper models how firms choose between full transparency and selective disclosure over time, showing how factors like news flow and regulatory timing influence their disclosure strategies and reputation management.

Contribution

It introduces a dynamic model of voluntary disclosure decisions using a Poisson process and differential equations, revealing conditions for switching between transparency and sparing strategies.

Findings

Low news intensity favors continuous candid disclosure.

Higher news flow induces firms to switch strategies periodically.

Parameters like disclosure timing influence the frequency of strategy switching.

Abstract

In a continuous-time setting we investigate how the management of a firm controls a dynamic choice between two generic voluntary disclosure decision rules: one with full and transparent disclosure termed $\it{candid}$, the other, termed $\it{sparing}$, under which values only above a dynamic threshold are disclosed. We show how management are rewarded with a reputational premium for candour. The candid strategy is costly because the sparing alternative shields the firm from potential downgrades following low value disclosures. We show how parameters of the model such as news intensity, pay-for-performance and time-to-mandatory-disclosure determine the optimal choice of candid versus sparing strategy and the optimal time for management to switch between the two. The private news updates received by management are modelled with a Poisson process, occurring between the fixed mandatory disclosure dates, such as fiscal years or quarters, with the news received generated by a background Black-Scholes model of economic activity and of its partial observation. The model presented develops a number of insights, based on a very simple ordinary differential equation (ODE) characterizing equilibrium in a piecewise-deterministic model, derivable from the background Black-Scholes model. It is shown that in equilibrium when news intensity is low a firm may employ a candid disclosure strategy throughout, but will otherwise switch (alternate) between periods of being candid and periods of being sparing with the truth (or the other way about); that is, we are able to characterize when in equilibrium a candid firm will switch to adopting a sparing strategy. The model illustrates how parameters such as time to mandatory disclosure, news intensity and pay-for-performance may drive such switching behaviour. $\it{With\,constant\,pay\,for\,performance\,parameters,\,at\,most\,one\, switching\,occurs.}$