To Believe or Not to Believe
Journal of Financial Markets, February 1999
Posted: 29 Dec 1998
This paper provides a model to explain how suspicion in capital markets may alleviate moral hazard in unverifiable managerial disclosures. We model a stylized market as a non-cooperative game among three classes of agents: competitive risk-neutral market makers who set prices; a manager with private information, who chooses a report to maximize expected market price of the firm's security; and a trader who, after observing the report, may decide to seek costly information to maximize expected profits. Since the manager can influence the trader's information acquisition decision, the manager may choose to reveal even bad news to decrease the relative impact of order flows on prices. Our results explain a well-documented empirical regularity: manipulable accounting earnings reports are informative to financial markets. We also identify a testable restriction on abnormal returns during an event window: prices are more sensitive to order flows after good news than they are after bad news.
Note: This is a description of the paper and not the actual abstract.
JEL Classification: G14, M41, M44, D82
Suggested Citation: Suggested Citation