Bayesian Persuasion in the Presence of Discretionary Disclosure

• In Event: Analytical Models

Abstract

We consider a firm’s design of its financial reporting system when the firm incurs a significant loss if it does not meet a crucial threshold. If the financial reports were the only basis for updating beliefs by the outside party responsible for applying the threshold, the firm’s problem would fall into a class of sender-receiver games referred to as Bayesian persuasion. A key result in such games is a preference by the sender for imperfectly informative reports that enhance the likelihood of meeting, but not necessarily exceeding the threshold. Our innovation with respect to this class of games is the addition of a later stage at which the firm may receive private information and, if so, has discretion over its disclosure. This additional stage may induce the choice of a more or less informative financial reporting system than would otherwise be chosen, depending on the properties of the private signal and the prior beliefs. The net result of such a choice is therefore to change the probability of meeting the threshold. We show that this choice always reduces the firm’s expected benefit. Interestingly, an equilibrium in which the firm never discloses its private information may also exist.

Authors

• Beatrice Michaeli, UCLA Anderson

• Henry L Friedman, University of California, Los Angeles

• John Hughes, UCLA