Derek K. Chan
University of Hong Kong
Abstract: This paper develops a simple model that integrates public disclosures and firms' investment decisions with a stock market in which information traders have incentives to produce and trade profitably on information that firms do not already have, and relates to an investment decision that has not yet been taken. The optimal choice of financial disclosure policy of a firm is affected by the liquidity needs of the capital market and involves a trade-off between investment efficiency and the cost of capital. An equilibrium is derived in which the level of public disclosure, the amount of private information production, the liquidity of the market, the amount of investment, the trading profits of the informed trader, and the cost of capital are linked to specific characteristics of the firm, of the informed trader, and of the market. Comparative statics identify how the above variables are influenced by changes in the liquidity needs of the capital market.
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