To Believe or Not to Believe

40 Pages Posted: 25 Jul 1994

Multiple version iconThere are 2 versions of this paper

Date Written: February 1998

Abstract

This paper explains how the actions of skeptical traders can make manipulable earnings reports informative. Our model consists of a price-maximizing manager who chooses a cheap talk report, a profit-maximizing trader who may then seek costly information, and competitive market makers. Since the manager can influence the trader's information acquisition decision, the manager may choose to reveal even bad news to decrease the impact of order flows on prices. The paper provides foundations for treating positive and negative earnings surprises as good news and bad news respectively, even when external auditing cannot constrain opportunistic managers. Testable implications are derived.

Keywords: Cheap talk; Earnings disclosure, Market microstructure

JEL Classification: G14, G10, M40

Suggested Citation

Bhattacharya, Utpal and Krishnan, Murugappa (Murgie), To Believe or Not to Believe (February 1998). Available at SSRN: https://ssrn.com/abstract=2288 or http://dx.doi.org/10.2139/ssrn.2288

Utpal Bhattacharya

HKUST Business School ( email )

Clear Water Bay
Kowloon
Hong Kong

Murugappa (Murgie) Krishnan (Contact Author)

Yeshiva University ( email )

500 West 185th Street
New York, NY 10033
United States

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