Since the 2007–10 financial crisis, investors have been demanding more information and voluntary disclosure from companies. Research by Chicago Booth PhD candidate Frank Zhou suggests that once companies start to release more information, their voluntary disclosures can become persistent.
Zhou created a model that captures a disclosure cycle driven by investor learning. The cycle starts with investors being uncertain or pessimistic about a company’s profitability, which makes it more likely for a company to disclose information about unrealized forthcoming earnings. As investors learn from these disclosures, that in turn further affects what and how much information a company is willing to offer up.
“The model shows that investor learning affects disclosure in two ways,” he writes. First, when investors are more pessimistic, a company is more likely to voluntarily disclose information as the company—regardless of how it’s doing—tries to convey good news. Second, when investors are more uncertain about what to think, the likelihood of disclosure also increases.
According to Zhou’s model, the economic effects of investor learning are comparable to those of both firm profitability and managers’ information precision.
And once started, a cycle of disclosure can be hard to break. Suppose a company is 10 percent more likely to make a voluntary disclosure this year because of pessimistic investors. The next year, on average, the company is also 10 percent more likely to make another voluntary disclosure. The effect declines to 8 percent in the fifth year.
“If realized earnings fall short of investors’ expectations, the earnings shortfall will affect investors’ future beliefs and, by extension, managers’ disclosure decisions in future years,” Zhou writes.