ORCID

Jeremy Bertomeu, https://orcid.org/0000-0001-6746-5767

Language

English (en)

Publication Date

9-7-2026

Abstract

This paper develops a model of financing that jointly determi nes a firm’s capital structure, its voluntary disclosure policy, and its cost of capital. Investors who receive securities in return for supplying capital sometimes incur losses when they trade their securities with an informed trader. The firm’s disclosure po licy and the structure of its securities determine the information advantage of the i nformed trader, and hence the size of investors’ trading losses and the firm’s cost of ca pital. We establish a hierarchy of optimal securities and disclosu re policies that varies with the volatility of the firm’s cash flows. Debt securities a re often optimal, with the form of debt - risk-free, investment grade, or ”junk” - va rying with the firm’s cash flow volatility. Though the model predicts a negative as sociation between firms’ cost of capital and the extent of information firms disclose, more expansive voluntary disclosure does not causefirms’ cost of capital to decline. Mandatory disclosures alt er firms’ voluntary disclosures, their capital structure choi ces, and their cost of capital. Acknowledgement 1 We wish to thank seminar participants at Carnegie-Mellon University, Stanford University, University of California at Los Angeles??? and Wash- ington University in St. Louis, as well as the editor Paul New man and two anony- mous referees for comments on previous drafts of the manuscr ipt. Dye also wishes to thank the Accounting Research Center at Northwestern Univer sity for financial support. XXXXXX I. Introduction We develop a model that jointly explains a firm’s voluntary disclosure p olicy, its capital structure, and its cost of capital. While not previously recognized in the literature, it is intuitive that there should be a relationship between a firm’s capital s tructure and its disclo- sure policy, because – barring agency problems – managers will choo se their firm’s disclosure policy so as to maximize the market’s perceptions of the expected va lue of the firm’s owners’ residual claims. Hence, the form of those residual claims – equivalen tly, the form of the securities that the firm sells to investors – affects what managers m aximize. In turn, the firm’s disclosure policy and its capital structure choices affect the fi rm’s cost of capital. In the model we study, a firm receives capital by issuing securities t o investors that promise future cash payouts. The central feature of the model is that the amount investors are willing to pay for the securities may be less than the expected pre sent value of the securities’ cash payouts because the investors anticipate at the time they buy the securities that they may bear trading losses if they have to liquidate the secur ities “early” – i.e., before maturity. These potential trading losses arise because the marke t on which the securities are traded is presumed to be populated by some superiorly informed traders. Compensating investors for these expected trading losses ex anteconstitutes a cost the firm bears in raising capital: it is thesource of the “cost of capital” in our model. The firm’s manager can reduce investors’ expected trading losses by reducing the infor- mation asymmetry between the superiorly informed traders and th e market maker who sets the price for the securities. This can be accomplished in two related w ays. First, since the informed traders’ private information about the firm is likely to over lap with the manager’s privateinformation, themanager candisclose his privateinformatio n.1Second, themanager 1For simplicity, we use male pronouns to refer to the manager and - lat er on - the market maker, but 1

Document Type

Working Paper

Author's Department

Accounting

Author's School

Olin Business School

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