Discretionary Disclosures with Risk-Averse Investors'

We develop the first general equilibrium exchange economy with risk-averse investors where firm managers can voluntarily make costly, discretionary disclosures regarding the liquidating value of the firm. This extends the discretionary disclosure setting of Verrecchia (1983) by relaxing the assumption of mean-variance pricing. Instead, we derive the equilibrium prices when risk-averse investors optimally allocate funds between a risk-free bond and risky stocks. We establish that these prices are equivalent to prices that would prevail if investors were risk neutral using risk-adjusted variables. The intuition for the required change in probability measure is analogous to the intuition for the adjustments required for option pricing. We show that in this setting, managers' optimal discretionary disclosure strategy is characterized by a disclosure threshold. We provide comparative static results for changing costs, signal variances, and asset variances. Further, we show that the structure of the prices and strategies derived is robust to the introduction of correlation in the future firm values.probability measure