Disclosure Paternalism

Abstract

Investors lacking good judgment may miscalculate the strategic motives causing withholding of material information. The resulting inadequate professional skepticism encourages excessively optimistic expectations after a non-disclosure and break the economic forces causing immediate unravelling to full disclosure. A regulator may intervene to correct the problem by mandating disclosure over events that would be otherwise be withheld; however, such paternalistic interventions come with a severe drawback: over-protection prevents investors from learning to be skeptical through repeated experiences of non-disclosure losses. While an unregulated market will converge over time to full disclosure, paternalism will lead to cycles characterized by high levels of compliance followed by excessive optimism. The model further predicts an association between positive price drift and transparency, and explains why regulators may sometimes choose to shut down entire markets.