Costs and Benefits of Disclosure Changes

This paper examines sustained changes in disclosure quality as measured by analyst disclosure ratings, with a focus on disclosure quality deteriorations. The paper first shows that firms with deteriorating disclosure ratings experience decreasing stock returns, increasing bid-ask spreads, and increasing analyst forecast dispersions. The scale and direction of these changes are symmetric to the benefits previously documented for disclosure-increasing firms. Firms that allow their disclosure quality to decline forgo non-trivial benefits, suggesting that cost of disclosure is a significant element in disclosure decisions. Tests of firm characteristics indicate that the likelihood of disclosure quality declines is negatively associated with the interaction between capital demand and expected earnings performance, highlighting the situations when improving disclosure quality is endogenously costly. Profiling the sample firms shows that a higher percentage of disclosure-decreasing firms face disruptive events that imply higher uncertainty about their futures, suggesting that the declining scores these firms receive likely reflect circumstances beyond management control. The finding that the disclosure-decreasing firms issue public debt frequently suggests that disclosure quality declines do not deter public debt financing.