Voluntary Disclosure, Moral Hazard, and Default Risk

We study a dynamic moral hazard setting where the manager has private evidence that predicts the firm’s cash flows. Bad-news disclosure is rewarded by a lower borrowing cost relative to the no-evidence case, whereas no disclosure leads to higher borrowing costs. For a given capital structure, disclosure reduces the firm’s default risk by lowering its pay-for-performance sensitivity. However, for a set of low-profitability firms, the anticipation of future disclosure of information by managers lowers both firm value and managerial rents at the financing stage because of a reduction in the firm’s initial liquidity. The model can reconcile the empirical evidence on the effects of providing earnings guidance, especially for loss firms. This paper was accepted by Bruno Biais, finance. Funding: S. Fu is supported by the Shanghai Pujiang Program and the Program for Professor of Special Appointment (Eastern Scholar) at Shanghai Institutions of Higher Learning [Grant 0900000182]. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2023.4860 .