The asset pricing and real implications of relationship intensity disclosure

Abstract

Investors in financial markets are often uncertain about the relationship intensity between firms and have to rely on firms’ disclosure of such relationship intensity. We analytically study the asset pricing implications of this relationship intensity uncertainty and how such uncertainty affects firms’ incentives to form and disclose their relationship intensities (i.e., the real implications). We find that while such disclosure has a positive price impact by increasing the expected cash flow, it also has a negative impact by reducing the diversification benefit of investing in multiple firms that have more correlated cash flows. The price impact upon relationship intensity disclosure is therefore not monotone: it increases with the expected benefit of relationship and decreases with the risk of the underlying relationship. Our analysis implies that mandatory disclosure of firm relationship intensities may both destroy relationship development and reduce investor welfare, i.e., has adverse real consequences.