Public Soft information

In their annual 10-K reports, the managers of public firms usually include forward-looking disclo-sures, i.e. public statements about their firms' expected future performance, like e.g. future profits or future revenues. Provided that such forward-looking disclosures contain additional information, their release might reduce the information asymmetry between firm insiders and outsiders, and result into better financing terms for a public firm. Prima facie, the information content of forward-looking disclosures is ambiguous, since they are non-verifiable at the moment they are made, and since managers might try to improve the financing terms for their firms via the release of overly optimistic statements. However, misleading external investors via overly optimistic disclosures is costly for a manager: If she fails to live up to investors' optimistic expectations, her firm underlies significant legal risks, potentially resulting into costly lawsuits. Further, since the manager repeatedly interacts with external investors, and since her forward-looking disclosures are verifiable ex post, misleading investors today harms the manager's reputation for making accurate public disclosures. Hence, a manager faces a tradeoff between the immediate gain from an overly optimistic statement today, and the loss in reputation which arises if she does not meet investors' expectations. Our research aims at uncovering the economic factors which affect this tradeoff, and to provide empirical evidence for our findings.

We use an infinitely repeated game-theoretic model with incomplete information in order to examine the economic mechanisms which underlie a manager's forward-looking disclosures. Our model is based on the framework used in Mathis et al (2009), and features as central agent the manager of a public firm who privately observes in each period the quality of a risky investment project. The manager can (but need not) make a forward-looking disclosure about the project's quality in order to attract external finance from imperfectly informed investors. Investors will use the firm's past disclosures for their assessment of the credibility of the manager's public statement. We derive the following results: If forward-looking statements are associated with legal costs, it is not possible to sustain an equilibrium where a manager's disclosures convey no information to investors (like a babbling equilibrium). Further, we find that the managers of opaque and profitable firms are more likely to release forward-looking statements to the public. Under certain conditions on model parameters, their disclosures will be accurate, i.e. they will never mislead external investors.