Credibility of voluntary disclosure in financial firms^*

^*Accepted by Hong Hwang.

Abstract

Financial firms are more vulnerable to the investors’ lacking in confidence, and a speculative run could happen when all investors lose their confidence and withdraw simultaneously. In addition to the existing discussions on endogenous misreporting cost such as reputation, propriety and social norm effects, this paper demonstrated that the threat of speculative run can serve as an endogenous misreporting cost which prevents the bank manager from lying in their voluntary disclosures. Hence, voluntary disclosures such as management earnings forecast can be informative, and the degree of information revelation will be positively related to depositors’ perspectives on the random investment shock.

Keywords:

• Voluntary disclosure
• financial firms
• speculative run

Notes

^* Accepted by Hong Hwang.

1 For example, Elgers and Lo (1994) find analysts underreact to information in their own past forecast errors, earnings changes and stock returns; Lev and Thiagarajan (1993) and Abarbanell and Bushee (1997) find analysts do not efficiently recognize implications of fundamental signals for future earnings.

2 On the contrary, costly state falsification models assume the mis-reporting cost to be increasing in the magnitude of the difference between the reported and the true value of managers’ private information. See Dye (1988), Stein (1989), Fischer and Verrecchia (2000), Sankar and Subramanyam (2001), Dye and Sridhar (2004), Guttman, Kadan, and Kandel (2006) and Beyer (2009).

3 Speculation has helped widespreading the housing bubble in the US to become a global financial crisis. The housing bubble in the US happened after a period (1996–2006) of increasing housing prices. When housing prices started to drop moderately in 2006–2007, refinancing by subprime mortgage borrowers became more difficult and defaults and foreclosure activity increased dramatically. Due to innovations in securitization, the housing bubble is shared more broadly with investors through structured products such as hedge funds. As the rights to these mortgage payments have been repackaged into a variety of complex investment vehicles, generally categorized as mortgage-backed securities or collateralized debt obligations, many banks or hedge funds purchase these products for higher returns. As mortgage losses have mounted, investors have questioned the reliability of the credit ratings, especially those of structured products. Since many investors had not performed independent evaluations of these often-complex instruments, the loss of confidence in the credit ratings led to a sharp decline in the willingness of investors to purchase these products. Liquidity dried up, prices fell, and spreads widened (Bernanke 2007).

4 Goldstein and Pauzner (2004), Rochet and Vives (2004) have adopted the global game approach, and Temzelides (1997) has adopted the evolutionary game approach.

5 See Grossman and Hart (1980), Milgrom (1981), Milgrom and Roberts (1986).

6 We consider full disclosure of the bank’s portfolio decision. Examples for partially disclosure can be found in Davies and McManus (1991) and Matutes and Vives (2000).

7 An alternative setting by Peck and Shell (2003) is to assume that investors can still have their unit investment back if they are in the early queue of withdraws, and the bank serves by the sequential service constraint (see Wallace 1988).

8 Goldstein and Pauzner (2004) and Rochet and Vives (2004) have adopted the global game approach, and Temzelides (1997) has adopted the evolutionary game approach.

9 We are grateful.

Additional information

Funding

This work was supported The Ministry of Science and Technology, Taiwan [MOST103-2410-H-004-100-].