A Theory of Disclosure in Speculative Markets

This paper presents a theory of corporate disclosure in an environment where investors have heterogeneous beliefs and face short sale constraints. The disagreement between investors provides a motive for agents who start a firm to limit the amount of information which it releases to the public so as to create uncertainty and thereby sponsor speculation over its value. The incentive to commit the firm to imprecise disclosure is stronger when there is greater initial heterogeneity of beliefs among investors. The endogenous response of a firm's disclosure policy amplifies the overpricing caused by the underlying heterogeneity of beliefs. I extend the model to consider the case where investors also learn about a firm's profitability from the information released by other firms in the industry. This creates a strategic complementarity in the precision of information released by each firm. This complementarity suggests why corporate misreporting and episodes of speculation occur in waves. The complementarity between each firm's disclosure policy further amplifies the effect of the initial disagreement among investors upon the overpricing of each firm.