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When Is Ignorance Blissful?

Abstract

This paper characterizes a set of circumstances under which a firm will deliberately choose to obtain strictly less information despite the associated cost of inefficient project implementation. We demonstrate that when the possession of more detailed information produces a full disclosure in equilibrium leading to significant proprietary loss, obtaining less information can be the only way to minimize such proprietary loss. In this way, simultaneous consideration of both the choice of an information system and a disclosure policy demonstrates that subsequent disclosure concerns can make it optimal for the firm to choose a coarser information system a priori. We also demonstrate how the choice of an information system can determine the circumstances under which a financial contract between the firm and its investors exhibits the properties of either a debt or an equity contract. When the firm must also decide on the financial contract, it is possible for the coarser information system to improve the risk sharing between the firm and its risk averse investors, thereby strictly increasing the likelihood of the firm obtaining less information. Finally, our analysis generates several testable hypotheses including the asymmetric effect of increasing leverage on the firm's equity price change versus stock returns following a disclosure.

Type

Working Paper

Author(s)

Swaminathan Sridharan, Bala Balachandran

Date Published

2012

Citations

Sridharan, Swaminathan, and Bala Balachandran. 2012. When Is Ignorance Blissful?.

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