1. Disclosure as a Tool for Building Trust and Stimulating Investment
Radhika Lunawat
Econometric Society
2008 North American Summer Meeting
Carnegie Mellon University
19th June, 2008

2. Research Question Relation between disclosure and trust
Effect on managerial disclosure decisions
Effect on investment

3. Investment Game Berg, Dickhaut and McCabe, 1995 Sender Gets $10
Sends m
Keeps $10-m
Receiver
Gets 3m
Keeps k
Sends back
R= 3 m - k 3m
3m - k

4. Reputation Formation Round 1 Round 2 3m 3m Sender Gets $10 Sends m
Keeps $10-m
Sender
1) Gets $10
2) Sends m
3) Keeps $10-m
Receiver
1) Gets 3m
2) Keeps k
3) Sends back 3m-k
Receiver
1) Gets 3m
2) Keeps k
3) Sends back 3m-k
Sender
1) Gets $10
2) Sends m
3) Keeps $10-m
Receiver
1) Gets 3m
2) Keeps k
3) Sends back 3m-k
3m - k
3m - k

5. Results - Reputation Formation
Round 1
Per Cent Returned
100%
50% 0%
A B
Round 2
A B
100%
50% 0%
Per Cent Returned
Per Cent Sent
A vs B experienced vs. inexperienced. Important carryover is that reputation might be the impetus for designing organizatioins.

6. Period 1 of Reinvestment Gameα1
Re-invest (α1)
Retain (k1) R1 k1
I(m1)
Not Disclose A B
Return (R1)
Invest (I) (m1)
Disclose
Not
Invest (NI) NI
(10, 0)
Key
I => k1 + α1 + R1 = λ1 m1
λ1 ε {1, 2, 3, 4}
Nature chooses B to be trustworthy or untrustworthy

7. Period 2 of Reinvestment GameB A R2 α2 k2
Return(R2)
Re-invest (α2)
Retain (k2)
Not
Invest (NI)
Invest (I) (m2)
Not Disclose
Disclose
Key
NI => k2 + α2+ R2= λ2α1
I => k2 + α2+ R2 = λ2 (m2 + α1)
λ2 ε {1, 2, 3, 4}

8. Period 3 of Reinvestment GameB A R3 k3
Return (R3)
Retain (k3)
Not
Invest (NI)
Invest (I) (m3)
Not Disclose
Disclose
Key
NI => k3 + R3 = λ3α2
I => k3 + R3= λ3 (m3 + α2)
λ3 ε {1, 2, 3, 4}

9. Financial Statements and Assumptions
Income statement : (λt - 1) (αt-1 + mt)
Balance sheet : αt
Risk neutrality, no time discounting, additively separable utility
Trustworthy B always re-invests and discloses
He returns half of what he receives in last period

10. Equilibrium of Reinvestment Game
Sequential equilibrium
A’s threshold
B’s mixed strategy
Belief revision via Bayesian updating

11. Reporting Regimes Full Information Benchmark No Disclosure regime
Endogenous Disclosure
Income Statement only (Partial Disclosure)
Balance Sheet only (Partial Disclosure)
Both Income Statement and Balance Sheet (Full Disclosure)

12. Comparing across regimes
More investment in regimes with disclosure compared to no disclosure
More re-investment in regimes with disclosure compared to full information
Disclosure of income statement (balance sheet) increases if disclosure of balance sheet (income statement) is a possibility

13. Comparing across regimes (contd.)
Probability of disclosing income statement (balance sheet) decreases in probability of disclosing balance sheet (income statement)
Private-order reputation based institution
No dividend payout

14. Experiment Design Screening round Several sequences of 3 periods each
Perfect stranger matching
Treatments
No Financial Statements
Balance Sheet only
Income Statement only
Both Income Statement and Balance Sheet

15. Investment
Dickhaut, Lunawat, Waymire and Xin, 2007

16. Zero and Maximum Investments
Dickhaut, Lunawat, Waymire and Xin, 2007