Word-of-Mouth Communication, Noise-Driven Volatility, and Public Disclosure

Posted: 27 Dec 2018 Last revised: 28 Sep 2020

See all articles by Hao Xue

Hao Xue

Duke University - Fuqua School of Business

Ronghuo Zheng

The University of Texas at Austin - McCombs School of Business

Date Written: October 9, 2018

Abstract

This paper examines how a firm adjusts its disclosure quality in response to technological innovations that improve investors' private information. We show that more precise private information can endogenously amplify supply shocks and, hence, increase noise-driven (or non-fundamental) price volatility. We study how the firm reacts to such changes and derive a necessary and sufficient condition under which the firm improves its disclosure quality when investors are informed with better private signals. We then apply our model to study investors' private word-of-mouth communication. Our analysis highlights a "dark side" of word-of-mouth communication and a call for better public disclosure even if private communication is assumed to be unbiased and truthful. We provide empirical predictions regarding how price volatility, market depth, and firms' disclosure qualities would change as technological innovations, such as social media, facilitate information sharing among investors.

Keywords: Public Disclosure; Private Information; Word-of-Mouth Communication; Price Volatility

JEL Classification: D82, G14, M41

Suggested Citation

Xue, Hao and Zheng, Ronghuo, Word-of-Mouth Communication, Noise-Driven Volatility, and Public Disclosure (October 9, 2018). Journal of Accounting & Economics (JAE), Forthcoming https://doi.org/10.1016/j.jacceco.2020.101363, Available at SSRN: https://ssrn.com/abstract=3298151 or http://dx.doi.org/10.2139/ssrn.3298151

Hao Xue (Contact Author)

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States

Ronghuo Zheng

The University of Texas at Austin - McCombs School of Business ( email )

Austin, TX 78712
United States

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