Sri S. Sridhar

Resource Allocation Effects of Price Reactions to Disclosures

Capital market participants collectively may possess information about the valuation implications of a firms change in strategy not known by the management of the firm proposing the change. We ask whether a firms management can exploit the capital markets information in deciding either whether to proceed with a contemplated strategy change or whether to continue with a previously initiated strategy change. In the case of a proposed strategy change, we show that managers can extract the capital markets information by announcing a potential new strategy, and then conditioning the decision to implement the new strategy on the size of the markets price reaction to the announcement. Under this arrangement, we show that a necessary condition to implement all and only positive net present value strategy changes is that managers proceed to implement some strategies that garner negative price reactions upon their announcement. In the case of deciding whether to continue with a previously implemented strategy change, we show that it may be optimal for the firm to predicate its abandonment/continuation decision on the magnitude of the costs it has already incurred. Thus, what looks like “sunk†cost†behavior may in fact be optimal. Both demonstrations show that, in addition to performing their usual role of anticipating future cash flows generated by a managers actions, capital market prices can also be used to direct a managers actions. It follows that, in contrast to the usual depiction of the information flows between capital markets and firms as being one way — from firms to the capital markets — information also flows from capital markets to firms.

Financial Contracts, Opportunism and Disclosure Management

This article shows that if all variables that determine a firms future cash flows are not contractible, it can be ex ante optimal to design a financial contract that admits debtholders waiving debt covenants on a discretionary basis and firms investing opportunistically subsequent to contracting. Further, as the contractible variable becomes less informative, the contract attaches greater significance to it. Finally, uncertainty in the magnitude of reporting latitude induces aggressive reporting by the firm to avoid violating the covenant or to enhance the chances of a waiver. The debtholders respond by sometimes not allowing the firm to implement mutually beneficial projects.

Corporate responses to segment disclosure requirements

Abstract This paper shows through increasing disclosure requirements may induce firms to reduce their value-relevant disclosures. In the absence of segment reporting requirements, an incumbent firm may voluntarily disclose value-relevant information because it can use other, value-irrelevant, information to jam proprietary disclosures. However, when required to disclose segment data, the incumbent may aggregate proprietary information with other value-relevant information to deter entry by a rival. Hence, the firm does not disclose value-relevant information it would have revealed voluntarily in the absence of segment disclosure requirements. In such situations, requiring more disaggregate disclosures can actually decrease price efficiency.

Investment Implications of Information Acquisition and Leakage

This paper studies when a firm will acquire additional information about a potential new project by consulting outsiders, when doing so runs the risk of reducing the value of implementing the project as a consequence of information leakage. The analysis evaluates the firms information acquisition activities in both the presence and absence of moral hazard in project production.

Managerial Entrenchment, Reputation and Corporate Investment Myopia

In this paper, we demonstrate that informational asymmetries within a firm along with managerial labor market concerns can jointly result in investment myopia being equilibrium behavior. In contrast to earlier studies (like that of Shleifer and Vishny [1989]), we find that in the presence of both reputation and entrenchment incentives, managers invest in long-term projects for reputation building and short-term projects to entrench themselves. Further, we establish conditions under which delegating project selection is optimal, even though it requires that the owner tolerate short-term project selection. Finally, we present several empirical implications of our analysis.

Mandatory and Voluntary Disclosures: Dynamic Interactions: MANDATORY AND VOLUNTARY DISCLOSURES

Firms sometimes obtain soft private information about growth prospects along with hard information about current or past performance. In this environment, we find that optimizing disclosures over multiple periods yields nonlinear stock price reactions following both voluntary and mandatory disclosures. Further, we derive several predictions about distinct short‐run and long‐run effects of disclosures and nondisclosures on security prices. Under specified conditions, when the volatility of the firms earnings increases, the average contemporaneous and prospective post‐mandatory‐disclosure market premia (for voluntary disclosures over nondisclosures) rise, while farther‐in‐future market discounts (for such voluntary disclosures) also become larger. Our analysis moreover predicts that both the disclosure probability and the information content of nondisclosures can increase in the persistence of earnings.