Information Disclosure and Financial Markets: An Experimental Investigation

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AbstractThe disclosure of information regarding the financial condition of firms has been a centerpiece of financial market regulation since the passage of the Securities Exchange Act in 1934. Requirements have been refined and reinforced over time with regulations which was intended to improve the accuracy and reliability of corporate disclosures, and more recently mandates that banks and other financial institutions periodically report results of stress tests that assess the institution’s capacity to respond to highly adverse events. An important issue regards the amount of the information collected that regulatory authorities should disclose publicly. Although the disclosure of firm-specific information typically improves the price efficiency of markets, there are concerns about this on several fronts: Public disclosure may undermine risk sharing opportunities between banks, may drive firms to invest in short term projects that yield high immediate returns in lieu of more profitable longer term projects, and may interfere with the capacity of markets to effectively aggregate information. This project uses laboratory experiments to investigate the behavioral relevance of recent theoretical models that analyze these important issues on information disclosure in the financial markets.The project consists of three experiments. The first experiment evaluates a model which provides a framework for balancing the concern that excessive information disclosure of a bank’s condition may undermine the risk-sharing opportunities that interbank markets allow, against the general perception that disclosure improves price efficiency. The second experiment evaluates the predictions of a model that focuses on the issue that overly frequent disclosures may force institutions to forego more profitable long term projects in favor of alternative projects that yield higher short term returns. The third experiment evaluates the effects of different kinds of public disclosure on a market’s capacity to aggregate information. Overall, these experiments advances the body of knowledge on information disclosure in the financial markets.This award reflects NSF's statutory mission and has been deemed worthy of support through evaluation using the Foundation's intellectual merit and broader impacts review criteria.