Limits to Voluntary Disclosure in Efficient Markets

In competitive markets, prices offered by investors play a dual role: they must induce the firm to make truthful disclosures about its expected cash flows and they must also be efficient, i.e., equal the expected future cash flows to the buyer conditional on the disclosed information. We show that these requirements may exert opposing influences resulting in equilibrium disclosures being partial; that is, they might cause firms to reveal some, but not all, of the valuation relevant information possessed by the firm. We then characterize the maximal level of information that can be elicited through efficient prices. We apply our analysis to the study of voluntary disclosures in the context of equity offerings, leases and sale of tax-loss carry-forwards and compare these to the level of currently mandated disclosures under GAAP.