Why do Firms Gravitate to Selective Disclosure?

In this paper, we present a theoretical model to explain why firms gravitate to selective disclosure. We consider a setting where a firm chooses its disclosure policy to maximize its price informativeness (i.e., how much information is impounded in the price, measured by the posterior precision of true value conditional on the price) in a market with different types of traders. Through ex-ante acquisition of expertise, traders become sophisticated and improve their ability to better interpret the information disclosed by the firm. We show that firms sometimes prefer to disclose information selectively, providing information only to sophisticated traders, rather than to the public. The primary reason is that selective disclosure promotes the ex-ante expertise acquisition among traders. Consequently, under selective disclosure, the aggregate information quality is overall higher and prices are more informative than under public disclosure. However, selective disclosure may reduce uninformed investor welfare.