Voluntary disclosure under dynamic moral hazard

Shiming Fu and Giulio Trigilia
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Shiming Fu: University of Rochester
Giulio Trigilia: University of Rochester

No 448, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: We introduce voluntary disclosure in a dynamic agency model with non-verifiable cash flows. Evidence reduces the use of high powered cash incentives, and the optimal contract features ``pay for verifiable bad luck''. The firm solvency and liquidity dynamics can be implemented by long-term debt, equity, and a credit line with interest rate contingent on both the disclosed evidence and the reported cash flow. Against the conventional wisdom, more frequent expected disclosure might lower firm value ex ante. As more evidence becomes available, two countervailing forces shape the solvency and liquidity dynamics: while firm value becomes more persistent after disclosure of bad news, the firm faces higher interest rate charges both in low states (absent disclosure), and when cash flows are high. For low profitability firms, the two effects must induce a non-monotonicity in firm value: more widespread evidence leads to less firms surviving in the long run.

Date: 2018
New Economics Papers: this item is included in nep-bec and nep-cta
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed018:448

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