Disclosure Policy and Competition Cournot vs. Bertrand.

Abstract Disclosure of financial information is an essential ingredient of a well-functioning capital market. However, public disclosure of information can affect a disclosing firm negatively if market participants make strategic use of the information to their advantage. In the presence of such a "proprietary cost," a firm has to trade off the positive and negative effects of disclosure. In an oligopolistic environment, disclosure causes rival firms to respond. The response depends on the nature of competition and private information. Some firms benefit by hiding, and others by sharing, information. If firms do not disclose information voluntarily, mandating disclosures will force firms to disclose information that they wish hidden. Mandating has no incremental effect if firms would have voluntarily disclosed the information. To promote more efficient (welfare-maximizing) disclosure policies, it is essential to understand how firms would behave in the absence of mandatory disclosure requirements. The purpose of this article is to analyze that behavior. A two-stage model of a duopoly is formulated to analyze firms' incentives to disclose private information. The incentives depend on whether firms are engaged in Cournot or Bertrand competition, and whether the private information is about demand or cost. Both ex ante incentives to precommit to a disclosure policy and ex post incentives to disclose voluntarily are examined. Ex ante, firms would not commit to disclosure in Cournot/demand and Bertrand/cost cases. Although Cournot duopolists would not commit to disclosure of information about demand, both firms and consumers might be better off if disclosure were enforced by regulatory agencies such as the Securities Exchange Commission (SEC) or the Financial Accounting Standards Board (FASB). Firms would commit to share information in the cases of Cournot/cost and Bertrand/demand. However, firms' incentives diverge ex post because the benefit of disclosure depends on the realized value of the signal. When the existence of private information is suspected, but not disclosed, nondisclosure is attributed to the type of signal that is better undisclosed. Thus, in equilibrium, it is difficult for firms to hide information successfully. In the Cournot/demand case, virtually all values of private information would be disclosed. In contrast, in Bertrand/cost, disclosure would seldom be observed when products are good substitutes. The model developed in this article identifies the environments in which mandatory disclosure rules are most effective: (1) when firms have the incentive to precommit to nondisclosure and (2) when voluntary disclosure is least likely in the absence of precommitment.