Moral Hazard and the Corporate Information Environment

Abstract

Much of corporate managers’ incentive is related to the stock price. Consequently, a firm can design its corporate information environment to tackle its manager’s moral hazard problem. We analyze a model in which the manager needs to exert costly effort to implement a risky, long-term project and the project gives the manager opportunities to make credible disclosure. The optimal disclosure to motivate effort is the manager’s strategic disclosure because it protects the manager from the downside of the project and induces the rational stock market to punish nondisclosure. A more transparent information regime is not always preferred because it may reduce the manager’s discretion on disclosure. We also derive the optimal disclosure when both the effort and the project choice are considered.