Disclosure Processing Costs, Investors¢â‚¬â„¢ Information Choice, and 2020-03-18¢  Disclosure Processing

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  • Disclosure Processing Costs, Investors’ Information Choice, and Equity Market Outcomes:

    A Review

    Elizabeth Blankespoor University of Washington

    Ed deHaan University of Washington

    Ivan Marinovic Stanford University

    10/1/19

    Working draft – suggestions welcome

    Abstract

    This paper reviews the literature examining how costs to monitoring, acquiring, and analyzing firm disclosures – collectively, “disclosure processing costs” – affect investor information choices, trades, and market outcomes. When investors face disclosure processing costs, learning from a disclosure is an active economic choice, and investors expect to be compensated for their costly processing activities. We review the analytical and empirical literature on sources of processing costs and how these costs affect price informativeness, responsiveness, liquidity, volatility, and volume within rational equilibria. We also discuss studies of the feedback effects of investors’ processing costs on managers’ choices about disclosure and corporate actions. We conclude that disclosure processing costs, and likely information frictions more broadly, have implications for a wide array of accounting research and phenomena, but we are only just beginning to understand their effects.

    We appreciate the support of John Core, Wayne Guay, and all the JAE Editors. Helpful comments were provided by Neil Bhattacharya, Henry Friedman, Mirko Heinle, Doron Israeli, Russ Lundholm, Matt Lyle, Josh Madsen, Phil Quinn, Nemit Shroff, Kevin Smith, Dan Taylor, John Wertz, Hal White, Teri Yohn, Gwen Yu, Sarah Zechman, and workshop participants at Arizona State University. Data were kindly provided by Lucile Faurel, Robin Litjens, Josh Madsen, James Ryan, Shiwon Song, John Wertz, and Christina Zhu. All omissions, errors, and views are our own. Contact information: blankbe@uw.edu; edehaan@uw.edu; imvial@stanford.edu.

    mailto:blankbe@uw.edu mailto:edehaan@uw.edu mailto:imvial@stanford.edu

  • 1. INTRODUCTION .................................................................................................................................................. 1 2. CONCEPTUAL UNDERPINNINGS .................................................................................................................... 6

    2.1 DISCLOSURE PROCESSING COSTS ................................................................................................................................ 8 2.2 INTRODUCING FIVE MARKET OUTCOMES ..................................................................................................................... 11 2.3 MODELS OF DISCLOSURE PROCESSING COSTS ............................................................................................................... 12

    2.3.1 Classic rational models ............................................................................................................................. 13 2.3.2 Behavioral models .................................................................................................................................... 14 2.3.3 Models of rational inattention ................................................................................................................. 15

    2.4 EFFECTS OF PROCESSING COSTS ON MARKET OUTCOMES ................................................................................................ 16 2.4.1 Price informativeness ............................................................................................................................... 17 2.4.2 Price responsiveness ................................................................................................................................. 18 2.4.3 Liquidity .................................................................................................................................................... 20 2.4.4 Volatility ................................................................................................................................................... 21 2.4.5 Trading volume......................................................................................................................................... 21

    2.5 CONCLUSIONS AND DIRECTIONS ................................................................................................................................ 23 3. DESCRIPTIVE ANALYSES ............................................................................................................................... 26

    3.1 MEASURES OF DISCLOSURE PROCESSING ACTIVITIES ...................................................................................................... 27 3.2 MEASURES OF LIQUIDITY, PRICE RESPONSIVENESS, VOLATILITY, AND PRICE INFORMATIVENESS ............................................... 30

    4. EMPIRICAL LITERATURE ON VARIATION IN PROCESSING COSTS ................................................ 35 4.1 INTRA-INVESTOR VARIATION IN PROCESSING COSTS ...................................................................................................... 35

    4.1.1 Variation in opportunity costs .................................................................................................................. 35 4.1.2 Intra-investor variation in capacity and explicit costs .............................................................................. 39 4.1.3 Allocation of scarce processing resources ................................................................................................ 40 4.1.4 Conclusions and directions ....................................................................................................................... 41

    4.2 INTER-INVESTOR VARIATION IN PROCESSING COSTS ....................................................................................................... 42 4.2.1 Inter-investor variation in processing costs: disclosure usage and trading volume ................................. 43

    4.2.1.1 Small investors ................................................................................................................................................... 44 4.2.1.2 Large investors ................................................................................................................................................... 47 4.2.1.3 Conclusions and directions ................................................................................................................................. 49

    4.2.2 Inter-investor variation in effects of processing costs: market effects other than volume ....................... 51 4.2.2.1 Cross-sectional tests based on shareholder composition ................................................................................... 51 4.2.2.2 Analysis of investor group activity ..................................................................................................................... 52 4.2.2.3 Conclusions and directions ................................................................................................................................. 55

    4.3 PROCESSING COST VARIATION ACROSS DISCLOSURES AND FIRMS ..................................................................................... 55 4.3.1 Inherent complexity and properties of the underlying event/firm ........................................................... 55 4.3.2 Disclosure construction and presentation ................................................................................................ 57

    4.3.2.1 Effects of financial reporting standards – comparability versus complexity ....................................................... 57 4.3.2.2 Disclosure location and formatting ..................................................................................................................... 59 4.3.2.3 Qualitative disclosure and linguistic properties .................................................................................................. 62

    4.3.3 Dissemination channels and timing .......................................................................................................... 67 4.3.4 Peer firm disclosure transfers .................................................................................................................... 69 4.3.5 Conclusion and Directions ......................................................................................................................... 69

    4.4 MARKET TECHNOLOGIES ......................................................................................................................................... 70 4.4.1. Financial reporting technologies ............................................................................................................. 70 4.4.2. Algorithmic trading ................................................................................................................................. 72 4.4.3. Technology advances in trading platforms and investment vehicles ...................................................... 74 4.4.4. Conclusions and directions ...................................................................................................................... 76

    5. THE EFFECTS OF INTERMEDIARIES ON DISCLOSURE PROCESSING COSTS ............................... 76 5.1. DATA PROVIDERS .................................................................................................................................................. 77

    5.1.1. Conclusions and directions ...............................................................................................................