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The Real Costs of Financial Efficiency When Some Information Is Soft

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  • Alex Edmans
  • Mirko S. Heinle
  • Chong Huang

Abstract

This article shows that improving financial efficiency may reduce real efficiency. While the former depends on the total amount of information available, the latter depends on the relative amounts of hard and soft information. Disclosing more hard information (e.g., earnings) increases total information, raising financial efficiency and reducing the cost of capital. However, it induces the manager to prioritize hard information over soft by cutting intangible investment to boost earnings, lowering real efficiency. The optimal level of financial efficiency is non-monotonic in investment opportunities. Even if low financial efficiency is desirable to induce investment, the manager may be unable to commit to it. Optimal government policy may involve upper, not lower, bounds on financial efficiency.

Suggested Citation

  • Alex Edmans & Mirko S. Heinle & Chong Huang, 2016. "The Real Costs of Financial Efficiency When Some Information Is Soft," Review of Finance, European Finance Association, vol. 20(6), pages 2151-2182.
    • Handle: RePEc:oup:revfin:v:20:y:2016:i:6:p:2151-2182.
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    File URL: http://hdl.handle.net/10.1093/rof/rfw030
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    References listed on IDEAS

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    Cited by:

    1. Goldstein, Itay & Yang, Liyan, 2019. "Good disclosure, bad disclosure," Journal of Financial Economics, Elsevier, vol. 131(1), pages 118-138.
    2. Tuo, Ling & Rezaee, Zabihollah & Gao, Lei, 2024. "Is there a tradeoff between management earnings forecasts and sustainability reporting?," Global Finance Journal, Elsevier, vol. 59(C).
    3. Bingler, Julia Anna & Kraus, Mathias & Leippold, Markus & Webersinke, Nicolas, 2024. "How cheap talk in climate disclosures relates to climate initiatives, corporate emissions, and reputation risk," Journal of Banking & Finance, Elsevier, vol. 164(C).
    4. Cyrus Aghamolla & Carlos Corona & Ronghuo Zheng, 2021. "No reliance on guidance: counter‐signaling in management forecasts," RAND Journal of Economics, RAND Corporation, vol. 52(1), pages 207-245, March.
    5. Yongtae Kim & Lixin (Nancy) Su & Xindong (Kevin) Zhu, 2017. "Does the cessation of quarterly earnings guidance reduce investors’ short-termism?," Review of Accounting Studies, Springer, vol. 22(2), pages 715-752, June.
    6. Haga, Jesper & Högholm, Kenneth & Sundvik, Dennis, 2022. "Peer firms’ reporting frequency and stock price synchronicity: European evidence," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 49(C).
    7. Stefano Filomeni & Udichibarna Bose & Anastasios Megaritis & Athanasios Triantafyllou, 2024. "Can market information outperform hard and soft information in predicting corporate defaults?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 29(3), pages 3567-3592, July.
    8. Davide Cianciaruso & Sri S. Sridhar, 2018. "Mandatory and Voluntary Disclosures: Dynamic Interactions," Journal of Accounting Research, Wiley Blackwell, vol. 56(4), pages 1253-1283, September.
    9. Dahlström, Petter & Lööf, Hans & Sahamkhadam, Maziar & Stephan, Andreas & Lu, Emma Rui, 2023. "Science-based emission targets and risk-adjusted portfolio return: An analysis using global SBTi-validated stocks," Working Paper Series in Economics and Institutions of Innovation 492, Royal Institute of Technology, CESIS - Centre of Excellence for Science and Innovation Studies.
    10. Josef Schroth, 2020. "Outside Investor Access to Top Management: Market Monitoring versus Stock Price Manipulation," Staff Working Papers 20-43, Bank of Canada.
    11. Yang, Ann Shawing, 2020. "Misinformation corrections of corporate news: Corporate clarification announcements," Pacific-Basin Finance Journal, Elsevier, vol. 61(C).
    12. Sualihu, Mohammed Aminu & Rankin, Michaela & Haman, Janto, 2021. "The role of equity compensation in reducing inefficient investment in labor," Journal of Corporate Finance, Elsevier, vol. 66(C).
    13. Andrew Hertzberg, 2018. "A Theory of Disclosure in Speculative Markets," Management Science, INFORMS, vol. 64(12), pages 5787-5806, December.
    14. Jyh-An Lee & Lauren Yu-Hsin Lin, 2022. "Legal Institutions of Human Capital: Property, Contract, and Organisation," Journal of the Knowledge Economy, Springer;Portland International Center for Management of Engineering and Technology (PICMET), vol. 13(4), pages 3326-3344, December.
    15. Alex Edmans, 2023. "The end of ESG," Financial Management, Financial Management Association International, vol. 52(1), pages 3-17, March.
    16. Guangyang Wang & Junwei Bai & Jian Xing & Jianfei Shen & Erli Dan & Xinyuan Zheng & Ludan Zhang & Peng Liu & Renchi Feng, 2023. "Operational Efficiency and Debt Cost: The Mediating Effect of Carbon Information Disclosure in Chinese Listed Companies," Sustainability, MDPI, vol. 15(2), pages 1-18, January.
    17. Roychowdhury, Sugata & Shroff, Nemit & Verdi, Rodrigo S., 2019. "The effects of financial reporting and disclosure on corporate investment: A review," Journal of Accounting and Economics, Elsevier, vol. 68(2).
    18. Koga, Yuya & Yamaguchi, Tomoyasu, 2023. "Does mandatory quarterly reporting induce managerial myopic behavior? Evidence from Japan," Finance Research Letters, Elsevier, vol. 56(C).
    19. Andres Christian & Jacob Martin & Ulrich Lennart, 2019. "Takeover Protection and Firm Value," Review of Law & Economics, De Gruyter, vol. 15(1), pages 1-46, March.
    20. Itay Goldstein, 2023. "Information in Financial Markets and Its Real Effects," Review of Finance, European Finance Association, vol. 27(1), pages 1-32.
    21. Vincent Tena, 2023. "The Consequences of Regulating Agency Friction on an Optimal Contract," Post-Print hal-04722609, HAL.

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    More about this item

    Keywords

    Financial efficiency; Real efficiency; Managerial myopia; Investment; Disclosure; Cost of capital;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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