Costly Public Disclosure and the Choice Between Private and Public Debt

Dan S. Dhaliwal
The University of Arizona

Inder K. Khurana
University of Missouri–Columbia

Raynolde Pereira
University of Missouri–Columbia

Abstract: Extant theory posits that disclosure serves to attenuate the information asymmetry component of the cost of capital. However, theory also identifies the costs of public disclosure and as a result points to an interior optimal level of disclosure. This paper examines the implications of costly disclosure within the context of a firm’s financing choice between private and public debt. Because private debt avoids costly public disclosure, we posit that firms who discern disadvantages in disclosing private information will find it cost efficient to raise funds in private debt markets. Using a sample of incremental financing decisions, we find that firms are more likely to issue private debt when the level of total firm disclosure (our proxy for costly disclosure) is low. We also find that the use of private debt decreases with the level of timely disclosure and the level of investor relation activities. These results hold after controlling for several firm-specific characteristics that influence the choice between private and public debt.

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