Incentives for Risk Reporting with Potential Market Entrants

Abstract

We analyze a situation in which an incumbent firm, endowed with private information about a risk factor in its market, can credibly disclose quantitative risk information to the market and, thus, also to its opponents. Favorable information increases the market price of the firm, but it may also induce the opponent to enter the market, which imposes a proprietary cost on the firm. We show that there exist partial-disclosure equilibria with two distinct nondisclosure intervals. If the firm does not disclose, the opponent will not enter the market. We conclude that one reason for the empirically observed lack of quantitative risk disclosure is the fact that firms are required to explain the underlying assumptions and models that they use to measure the risk, which can lead to important competitive disadvantages.