Disclosure under Noisy Information Processing

Abstract

Capital markets process disclosures with noise. Adding this single friction overturns the standard characterization of costly voluntary disclosure. Firms may unravel to full disclosure despite strictly positive disclosure costs and, when unravelling fails, the model generically admits two equilibria rather than one. In the lower-threshold equilibrium, disclosure becomes more frequent as the cost rises and as reports become more accurate, falls with fundamental volatility when it is below the processing noise, but approaches full disclosure again when volatility grows large. These results help explain the mixed empirical evidence on the proprietary cost hypothesis and generate conditional predictions that distinguish high and low disclosure regimes. The model also explains why ESG ratings can be noisy, costly, and widely purchased, while still influencing market prices.

arXiv comment62 pages, including the Online Appendix. JEL classifications: D82, D83, G14, M41