Disclosing to Rationally Inattentive Traders

The paper investigates firm managers’ strategic disclosure interactions of quantitative value estimates when facing a rationally inattentive trader who also gathers qualitative information. Considering a model with two firms and using the Kyle (1985) model to price each firm’s securities, I show that a trader shifts more attention towards the firm priced in a more liquid market. Myopic firm managers are interested in short-term price development. Increased trader attention results in an increased investment volume, thus relaxing the inherent underinvestment problem and increasing efficiency. Due to scarce trader attention, two fundamentally uncorrelated firms’ decisions are interconnected. I show that increased precision in public disclosure of one firm shifts trader attention to the other firm. This positive externality stems from the general uncertainty reduction of firm disclosure. I show that (opposed to Fishman and Hagerty (1989)) firms expend too few resources on disclosure. This underinvestment in public disclosure, compared to the social optimum increases in public disclosure precision, is non-monotonic in noise trading activity in the secondary market as well as the cognitive limitation of the trader. Further coordination failures between firm managers are identified, which creates demand for disclosure regulation. Overall, the paper suggests (and identifies) that disclosure regulation should be used on specific target firms to optimize the outcome of the regulation