Optimal Leverage and Strategic Disclosure

Giulio Trigilia - Feb 14, 2017

I consider a market where firms compete under costly-state-verification and can commit to disclose information about future profits (e.g., going public). The cost of disclosure increases in the signal to noise ratio, and disclosure externalities benefit other firms by improving the information environment. I characterize the jointly optimal disclosure policy and capital structure, and show that the two are deeply intertwined. The optimal capital structure consists of a mixture of debt and equity, and leverage is negatively correlated to transparency. Because of information externalities, firms under-disclose relative to the constrained best and, as a result, equilibrium leverage is excessively high. Regulators might intervene setting disclosure and capital standards. The limited commitment extension of the model provides similar qualitative insights, and an even stronger role for regulation.

disclosure optimal leverage asymmetric information capital structure