Disclosure and Exchange of Inside Information*

• Published date: 01 March 2021
• Author: Rui Cao,Yongli Zhang
• Date: 01 March 2021
• DOI: http://doi.org/10.1111/irfi.12261

Disclosure and Exchange of Inside

Information*

RUI CAO AND YONGLI ZHANG

China Economics and Management Academy, Central University of Finance and

Economics, Beijing, China

ABSTRACT

This paper investigates how cooperation of stock analysts can affect volun-

tary disclosures of corporate inside information. Previous studies show that

corporate insiders have incentives to disclose the information commonly

shared by stock analysts, taking stock analysts’actions as given. We focus on

the strategic interactions between corporate insiders and stock analysts, and

between stock analysts themselves. We show that voluntary disclosures may

occur only when stock analysts intend to share their specialized information.

In some sense managers are “forced”to disclose information because if they

do not, stock analysts’information sharing would put them at a disadvan-

tage. Our results highlight the role of information exchange between stock

analysts in stimulating voluntary disclosures, and provide an alternative

explanation of managers’motives for voluntary disclosures.

JEL Codes: D82; G14

Accepted: 15 February 2019

I. INTRODUCTION

This paper studies how cooperation of stock analysts can affect voluntary dis-

closures of corporate inside information. Prior research (Bushman and Indjeji-

kian 1995; Shin and Singh 2010) finds that insiders may voluntarily give up a

portion of their private information for their own benefit. The reason lies

behind the price formation process that incorporates all available information.

With the truthful disclosure of partial inside information, reduced uncertainty

regarding the fundamental value of a company decreases price sensitivity and

increases market depth. Although some information advantage is sacrificed

through disclosure, more can be gained with undisclosed inside information.

The above story is interesting because it seems contrary to the common

belief that inside information is best utilized undisclosed. However, the condi-

tions under which it can occur is not adequately addressed in the literature.

Moreover, existing theoretical research rarely considers the strategic

* Yongli Zhang acknowledges financial support from the China International Center for Economic

and Technical Exchanges.

© 2019 International Review of Finance Ltd. 2019

International Review of Finance, 21:1, 2021: pp. 183–207

DOI: 10.1111/irfi.12261

interactions between corporate insiders and stock analysts, or between stock

analysts themselves.

We hope to contribute to the literature by focusing on these interactions. We

extend the work of Shin and Singh (2010) and find that the strategic interactions

between analysts and managers are crucial in determining corporate insiders’

motives to disclose. We show that corporate insiders’willingness to disclose

completely vanishes when stock analysts do not want to exchange their special-

ized information. Therefore, stock analysts’desire to share information is necessary

for voluntary disclosures. Furthermore, under some restriction on the relative

amount of differential information, stock analysts’inclination to exchange infor-

mation is also sufficient to induce voluntary disclosures of corporate insiders.

Our model adopts the baseline framework of Kyle (1985), Holden and Subrah-

manyam (1992), and Foster and Viswanathan ( 1996). We partition the funda-

mental value of a company into three components: market, industry, and firm.

The market component relates to general market conditions and sentiment that

determine the overall level of valuation. The industry component is information

on the prospects and growth opportunities of an entire industry. And the firm

component is any material information that is specifictoafirm, but is not

reflected in the market and industry component. The empirical research of Pio-

troski and Roulstone (2004) provides justification for such categorization.

We consider a corporate manager, two stock analysts, a market maker and

some noise traders. Both the manager and the stock analysts have inside infor-

mation, but with different and partially overlapping types. The manager has

direct access to the industry and firm-specific information, but has no informa-

tion regarding the market. He has the option of disclosing his inside informa-

tion on the industry and/or the firm. One stock analyst specializes in

discovering the industry information, while the other the market information.

They have the option to cooperate and exchange their specialized information.

Assuming separate information sources is designed to capture the notion

that traders in financial markets are usually asymmetrically informed. First, it is

well known in the financial service industry that stock analysts have different

specializations. Second, while managers naturally have better access to firm and

industry information, stock analysts tend to be better at discovering market and

industry information. Indeed, in their comprehensive review on the empirical

literature of information disclosure, Healy and Palepu (2001) conclude that

stock analysts generate new information through their activities.

The analysts would only share their specialized information when each ana-

lyst’s amount of information (represented by variance) is similar to each other.

This makes sense because cooperating must be mutually beneficial, and on rela-

tively equal terms. The industry analyst is in a weaker position because the

manager also has the industry information, and could make it public. We find

that it takes approximately twice the amount of industry information as much

as the amount of market information in order to convince the market analyst

of cooperating. When the information advantage of one analyst is too high rel-

ative to that of the other, cooperation will not occur.

© 2019 International Review of Finance Ltd. 2019184

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