Public disclosure in acquisitions

• Author: Wenyuan Xu,Avanidhar Subrahmanyam
• Published date: 01 January 2018
• Date: 01 January 2018
• DOI: http://doi.org/10.1002/rfe.1017

ORIGINAL ARTICLE

Public disclosure in acquisitions

Avanidhar Subrahmanyam

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Wenyuan Xu

Anderson Graduate School of

Management, University of California at

Los Angeles, Los Angeles, CA, USA

Correspondence

Avanidhar Subrahmanyam, Anderson

Graduate School of Management,

University of California at Los Angeles,

Los Angeles, CA, USA.

Email: asubrahm@anderson.ucla.edu

Abstract

This paper analyzes firms’optimal choice of information disclosure beforean acquisi-

tion. The intuition is that value-maximizing firms face the following tradeoffs. First, a

more precise disclosure reduces risk premia. Second, too precise a disclosure that

allows targets to profit increases the price paid for the target in an acquisition. The

main conclusion is that firm chooses to disclose either all information or the minimum

information required by the regulators, depending on the disclosure requirements,

investors’risk aversion, and the uncertainty embedded in technology shocks.

KEYWORDS

asymmetric information, information disclosure, market efficiency

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INTRODUCTION

Public firms frequently release information to the public, sometimes even beyond what is required by regulation. Research-

ing the determinants of firm’s disclosure policy helps understand how firm actively changes its information environment. It

also contributes to determining the optimal amount of disclosure regulation.

As Healy and Palepu (2001) point out, there are six factors impacting managers’disclosure decisions: capital market

transactions (e.g., cost of capital effects), corporate control contests, stock compensation , litigation costs, proprietary costs,

and management talent signaling. In this paper, we focus on the cost of capital and proprietary costs.

Due to an adverse selection problem, managers have the incentive to voluntarily disclose information and reduce the cost

of capital. Myers and Majluf (1984) indicate that firms have the incentive to disclose information voluntarily when making

public offerings. The higher the information asymmetry between management and shareholder, the higher the risk associated

with the security and thus the lower the price. Similarly, Barry and Brown (1985, 1986) and Merton (1987) argue that when

managers have superior information, investors demand an information risk premium if this information risk is not diversifi-

able. Diamond and Verrecchia (1991) and Kim and Verrecchia (1994) suggest that voluntary disclosure reduces the informa-

tion asymmetry between uninformed and informed investors, increases the liquidity of a firm ’s stock and raises the price.

Easley and O’Hara (2004) believe that uninformed traders will face bigger risk when facing information asymmetry because

informed traders can shift their weight to adjust for new information. There is also plenty of direct and indirect evidence sup-

porting this view. Botosan (1997) shows that for firms with low analyst following, the cost of capital decreases in the degree

of voluntary disclosure. Botosan and Plumlee (2000) find a negative relation between cost of capital and analyst rankings of

annual report disclosures. Gelb and Zarowin (2002) find that firms with high disclosure ratings have high stock prices relative

to firms with low disclosure ratings. Welker (1995), Healy, Hutton, and Palepu (1999), Leuz and Verrecchia (2000), and Coller

and Yohn (1997) document that bid-ask spreads are lower for firms with higher level of disclosure. This finding could be

viewed as an indirect support since research (e.g., Brennan & Subrahmanyam 1996) suggest that bid-ask spreads are positively

related to the cost of capital. A survey by Graham, Harvey, and Rajgopal (2005) finds that more than four in five of the execu-

tives in their sample concur that the cost of capital or reduction of information risk is a motivation for voluntary disclosures.

However, firms might not adopt a full disclosure policy in reality. The unraveling result (Milgrom, 1981) implies that firm

may hide information in equilibrium when disclosure is costly. A proprietary cost is often introduced to invoke partial disclo-

sure. The idea is that firm may strategically hide information from the market to remain competitive in the pro duct market. The

Received: 6 December 2017

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Accepted: 21 December 2017

DOI: 10.1002/rfe.1017

Rev Financ Econ. 2018;36:3–11. wileyonlinelibrary.com/journal/rfe ©2018 The University of New Orleans

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