Disclosure-disciplining mechanisms: Capital markets, product markets, and shareholder litigation

John H. Evans*, S. Sridhar

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

50 Scopus citations

Abstract

This paper demonstrates that a firm's trade-offs between reporting good news to reduce the cost of capital and bad news to minimize proprietary costs can induce the firm's manager to provide truthful disclosures when the opposing effects balance each other. We also show that greater proprietary costs can make a firm's disclosures more credible, increase the frequency of voluntary adverse disclosures, and improve the disclosing firm's welfare. Further, we find that potential shareholder litigation can interact with capital and product markets' influences to make voluntary disclosures more credible, but only under certain circumstances. For example, although product market competition can complement the capital market effects in inducing the manager to provide truthful disclosures, shareholder litigation cannot complement the capital market in the same way. Nevertheless, while shareholder litigation can never induce misreporting, a very strong product market influence can prompt a firm to underreport its true economic condition.

Original languageEnglish (US)
Pages (from-to)595-626
Number of pages32
JournalAccounting Review
Volume77
Issue number3
DOIs
StatePublished - Jul 2002

Keywords

  • Cost of capital
  • Disciplining mechanism
  • Proprietary costs
  • Share-holder litigation
  • Voluntary disclosures

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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