Outside investor access to top management: market monitoring versus managerial bias

Abstract

Voluntary disclosure can lower the cost of capital and improve market monitoring of managers. However, market participants may be uncertain about how much managers intend to bias any voluntary disclosure. Firm owners can adjust managerial compensation to mitigate uncertainty about managerial bias. This paper builds an optimal-contracting model to show how reductions in cost of capital and higher sensitivities of equity pay to performance need to be traded off against distortions in managerial compensation. The model predicts that, across firms, voluntary disclosure is positively related to managers’ bias and strength of equity incentives, and negatively to the cost of capital.