Definition

To make (company related) information accessible to interested parties.

Information Disclosure in Corporate Finance

In corporate finance literature information disclosure relates closely to investment and growth opportunities. Firms whose financing needs exceed their internal resources may suffer from financial market imperfections due to asymmetric information and incentive problems between corporate insiders and outside investors (see, e.g., Berger and Udell 1998; Hubbart 1998; Petersen and Rajan 1994). The informational opacity of a firm may reduce the availability of external finance to the firm because the more opaque the firm the more scope there is for opportunistic behavior by the firm’s insiders (more moral hazard) and the harder it is for investors to determine the quality of the firm (more adverse selection). This may lead to higher interest rates demanded by investors and higher risk investment projects chosen by a firm than in a situation in which all relevant information on firm’s financial status has been made accessible to potential investors. A conventional wisdom in the contemporary corporate finance literature argues the informational opacity of firms is in relation to firms’ age and size. Recent entrants with short track record suffer more from the informational opacity than incumbent firms. Smaller firms are also typically more opaque than larger firms because their minimum requirements for information disclosure, e.g., in financial statements, are more scant than in larger, especially in the listed, firms.

Firms can reduce their informational opacity by voluntarily disclosing high quality information on their business activities over and above mandated disclosure. High quality disclosure is especially important for firms with lucrative growth prospects because for them standard disclosure is of too low quality. It is of too low quality in the sense that mandated disclosure often alleviates information asymmetry only to a limited extent. This kind of higher quality disclosure incurs, however, costs to firms. There can be many types of costs. Direct costs arise from producing and credibly disclosing information. In addition to more comprehensive accounting processes, this may include, for instance, acquiring prestigious auditors and the premiums charged by them. Furthermore, indirect costs can arise from various reasons, such as the pro-competitive effects of disclosure (Bhattacharya and Chiesa 1995; Healy and Palepu 2001). Disclosure may also reduce the incentives of outside investors to acquire information (Boot and Thakor 2001). Firms have thus to balance with the costs of high quality disclosure with returns of growth opportunities. Titman and Trueman (1986) show in a formal model that the firms that choose high quality disclosure are, in equilibrium, those with favorable information about the firm’s future and its growth opportunities.

Information disclosure in corporate finance is related also to the interactions of the insiders of firms, i.e., corporate governance system. Hermalin and Weisbach (2012) argue that more transparent disclosure policies can in fact aggravate agency problems between managers and shareholders and increase firms’ costs due to higher rates of executives’ turnover and compensation demanded by them. Efforts to be more transparent can lead to a situation where managers are more reluctant to increase firm value in the long run but rather boost short-term investments and other actions that affect reported figures sooner at the expense of longer term (riskier) value creation investments, such as R&D.

Information Disclosure and Innovations

Besides corporate finance, information disclosure relates in economic literature also to generation of innovations. When a firm has made an innovation, it can basically choose to keep the innovation secret or apply for a patent. If the firm applies for the patent, it discloses the discovery of invention and provides information about it to the public. In addition, the patent applicant is obliged to reveal all prior art that may be relevant to the patentability of the applicant’s invention. This includes disclosing existing technological information on both documentary sources, such as patents and publications, and nondocumentary sources such as things known or used publicly, which is used to determine if an invention is novel and involves an inventive step (for further details on patenting process, see, e.g., European Patent Office’s www-pages http://www.epo.org).

When a firm is granted a patent on an invention, it gets a temporary monopoly right in exchange for disclosure. The monopoly right lasts normally 10 years. After the period of patent protection, the invention is freely available to competitors and other potential users. Other parties than the inventor can also utilize the patented innovation during the life of the patent by licensing and other arrangement facilitating a market for technological exchange. Social costs of disclosing the invention by patenting arise if this technological exchange does not perform well. In this case, patented inventions may hold up subsequent research on related inventions and may generate substantial transaction costs from costly legal challenges about possible infringement (see Gallini 2007 for a more detailed discussion of the role of disclosure in the case of patenting and Griliches 1990 for a review of patents as innovation and economic indicators).

Information Disclosure in Other Contexts

Besides corporate finance and innovations, the term information disclosure is used for instance in consumer economics in regard to how transparent information firms are willing to reveal on their products to consumers (see, e.g., Ghosh and Galbreth 2013; Polinsky and Shavell 2012).

Furthermore, in the field of competition analysis, information disclosure is used in the context of its influence on competition in the field of interest (see, e.g., Arya and Mittendorf 2013; Feltham et al. 1992; Hayes and Lundholm 1996). More detailed information disclosure reveals more data to competitors and can potentially weaken disclosing firm’s position in the market. On the other hand, an incumbent firm may strategically choose to disclose some information to prevent new entries in the market. In addition to competing firms, individual firm’s disclosures may have spillover effects also in noncompeting firms by revealing information on technological trends, governance arrangements, best policy practices, etc.

Cross-References