ORCID

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

Language

English (en)

Publication Date

2009

Abstract

This paper presents a theory that relates industry business fluctuations, or cycles, to firms’ vol- untary disclosure and industry concentration. In the model , a firm may be informed about market size in advance of its competitors and decide whether or not t o publicly disclose that information. We examine the cyclical behavior of disclosures, and their a ssociation with price-setting behavior and industry profits. We show that, in industries that are hig hly concentrated and/or feature lower cost of capital, no-disclosure is prevalent and associated with acyclical product prices and higher profits. Otherwise, disclosure occurs in normal times, whil e no disclosure occurs prior to either sharp industry expansions or industry declines. Consequen tly, strategic disclosure can work to reduce information available and dampen some of the effects of industry fluctuations. *Jeremy Bertomeu ([email protected]) is from the J.L. Kellogg School of Man- agement of Northwestern University and Pierre Jinghong Lia ng([email protected]) is from the Tepper School of Business at Carnegie Mellon University. Many than ks to Tim Baldenius, Mark Bagnoli, Ron Dye, Pingyang Gao, Jon Glover, Bjorn Jorgensen, Christian Leuz, DJ Nanda, Korok Ray, Bill Rogerson, Phil Stocken and other semi- nar participants at Carnegie Mellon University, Northwest ern University, the D-CAF conference at Copenhagen and the Chicago-Minnesota Theory conference. This paper originat ed from several discussions at the Tepper Repeated Games Reading Group and we wish to thank its participants, Edwige C heynel, Laurens Debo, Richard Lowery for their helpful feedback along this project. Industry business fluctuations or cycles, defined as the vari ations in economic activity levels (e.g., demand, production, market prices) experienced by an indus try over time, have been the object of an extensive literature in social sciences. However, fairl y little is known about the channels through which information about the cycle flows among participants t o the product market. In a world where some firms possess private information about the pending cyc le, strategic decisions may include infor- mation transmission decisions such as voluntary disclosur e. As such, corporate voluntary disclosure can affect and be affected by industry fluctuations. On the on e hand, voluntary disclosure (or lack thereof) can convey industry-wide information to other mar ket participants about the cycle, generat- ing (competitive) responses which shape the cycle itself. O n the other hand, the cycle affects the level and distribution of industry profits which, in turn, will pro vide incentives or disincentive to disclose firms’ private information. This paper develops a model that accounts for the two-way int eractions between industry fluctu- ations and firm voluntary disclosures. We propose a variant o f a standard repeated-game model of industry fluctuations which incorporates voluntary disclo sure into the existing literature on dynamic oligopolistic competition and relates it to characteristi cs of the industry such as concentration levels, cost of capital and the magnitude of shocks experienced by th e industry. In doing so, our analysis develops an argument leading to several testable predictio ns in terms of how disclosure accompanies industry-wide fluctuations. The idea that the economic environment may alter the amount a nd quality of information disclosed by firms is fairly intuitive. Naturally the cost and benefits o f voluntary disclosure will depend on the competitors’ responses to the disclosure. Such responses w ould, in turn, depend on how cooperative or competitive the competitors are, as well as the informati on contained in the disclosure (including news contained in a lack of disclosure). To illustrate such i ncentives further, consider the problem of a firm that is privately informed about an upcoming boom. Th is firm may prefer to retain that information in order to avoid the extra price competition th at a public disclosure of that information would generate. Alternatively, suppose that this firm recei ves information about an upcoming major downturn. The firm may now prefer industry prices to increase , to offset some of the reduction in quantities sold. Such a coordinated price increase, howeve r, requires the informed firm to disclose the upcoming downturn to its uninformed competitors. The effect of the industry fluctuations on external reportin g is, of course, not one-sided. The fluc- tuations of production, prices, and profits are not only affe cted by the common shock, but also the disclosure behavior. If, say, firms choose to disclose more i nformation about the industry demand to the marketplace, such information would allow otherwise un informed firms to adjust their production and prices in advance of the business cycle shock. Combined, they shape industry level of production and distribution of profit among member firms of the industry. Thus, how much the industry as a whole responds to a shock, then, depends on what information is being disclosed. As a result, firms’ disclosures will play an important role on how common shocks are translated into fluctuations in pro- 1

Document Type

Working Paper

Author's Department

Accounting

Author's School

Olin Business School

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