The Asset Pricing and Real Implications of Relationship Disclosure

In many scenarios, investors in financial markets are uncertain about the relationship between two firms and have to rely on firms' disclosure of such relationship. We develop a theory to study the asset pricing implications of this relationship uncertainty and how such relationship uncertainty affects firms' incentives to form and disclose their relationships to the public in the first place (i.e., the real implications). We find that while disclosing relationships has a positive price impact by increasing the expected cash flow, it also has a negative price impact by reducing the diversification benefit (or, equivalently, increasing the diversification cost) of investing in multiple firms that have more correlated cash flows. One main policy implication of our analysis is that mandatory disclosure of firm relationships may destroy relationship development. In other words, disclosing relationship information can have real consequences on cash flows through affecting firm relationships at both the intensive and the extensive margins