Information Disclosure, Intertemporal Risk Sharing, and Asset Prices

Disclosure of information triggers immediate price movements, but it mitigates price movements at a later date, when the information would otherwise have become public. Consequently, disclosure shifts risk from later cohorts of investors to earlier cohorts. Hence, disclosure policy can be interpreted as a tool to “control” interim asset price movements, and to allocate risk intertemporally. This paper shows that a policy of partial disclosure (and, hence, of intertemporal risk sharing) can maximize, but surprisingly also minimize, the market value of the firm. Our model also applies to a setting where a central bank chooses the quality and frequency of the disclosure of macroeconomic information, or to the precision of disclosure by (distressed) banks.Financial reporting, disclosure, information policy, asset pricing, intertemporal risk sharing, general equilibrium

Alternating offer bargaining with endogenous information : timing and surplus division

Two ex ante identically informed agents play a two-period alternating offer bargaining game over the division of a known surplus with endogenous information and common values. This paper shows that a low discounting of trading surplus, a positive externality of information acquisition and an endogenous lemons problem can cause delay of agreement. In the period of disagreement the buyer and the seller have symmetric information. For the case where the discount factor d of trading surplus is zero, a perfect equilibrium exists in which the responder captures full surplus in take-it-or-leave-it offer bargaining. The equilibrium payoff of the first period proposer can increase with d, the bargaining power of the counter party

On bargaining with endogenous information

Two ex ante identically informed agents play a double auction over the division of a trading surplus with endogenous information and common values. This paper shows that if information acquisition is not observable, three types of inefficiencies can arise. If the information cost is in an intermediate range, no pure strategy equilibrium with trade exists although the agents maintain symmetric information. If the information cost is low, any trading equilibrium exhibits costly information acquisition. If the agents face asymmetric information cost the Akerlof’s lemons problem arises as a self-fulfilling equilibrium and only partial trade occurs

Information acquisition in double auctions

This paper analyses information acquisition in the Reny and Perry (2006) type double auction environment and shows that an efficient and fully revealing equilibrium may fail to exist if information is endogenous and costly. As the number of traders increases, the equilibria are inefficient even though the information cost is very large. Because of endogenous noise trading, the price is also not fully revealing. This paper provides a strategic foundation for Grossman and Stiglitz (1980) and discusses some market microstructure implications

Opacity and the Optimality of Debt for Liquidity Provision +

Abstract Asymmetric information can reduce trade (possibly to zero) due to adverse selection. Symmetric information can facilitate trade. We show that trade between agents is maximized, and welfare highest, when neither party to a transaction has any information about the future payoffs of the securities used to trade. Trade is best implemented by debt which preserves ignorance because it provides the smallest incentive for private information production, which creates adverse selection. Debt's value is also least sensitive to public signals. In this economy policies that increase transparency would reduce welfare. Finally, even if there is adverse selection in the market, debt maximizes the amount of trade. For the economy as a whole there is a systemic risk of using debt to provide liquidity: an aggregate shock, if bad enough, can be made worse by triggering private information production, causing adverse selection when debt becomes information-sensitive

The Taxation of Bilateral Trade with Endogenous Information The Taxation of Bilateral Trade with Endogenous Information

Abstract This paper analyzes the effects of taxation on trade in a decentralized market. We show that a tax on profits and a transaction tax have opposite implications for information acquisition and trade in the canonical take-it-and-leave-it offer bargaining model. A (marginal) increase of a transaction tax can lead to more information production and lower the probability of efficient trade. In contrast, a (marginal) increase of a profit tax can reduce the incentive to produce information and increase the probability of efficient trade. The taxation of profits can be efficiency enhancing when information is endogenous, while it has no effect when private information is exogenous. Keywords: Bargaining; information acquisition; taxation; financial transaction tax; funding markets JEL Codes: C78; D82; D83; G18; H20 _______________________________ a Columbia University, e-mail: [email protected]. b Max Planck Institute for Tax Law and Public Finance, e-mail: [email protected]. 2 INTRODUCTION In this paper we analyze the effects of taxation on trade in a decentralized market where agents are uncertain about the value of the asset but can acquire information about the asset's payoff. We focus on two standard tax instruments (a tax on profits or capital gains and a sales tax) and show that, by changing the incentives to acquire information, taxation influences the endogenous problem of asymmetric information and hence the probability of trade. The question of how taxation affects information acquisition and bilateral trade is an interesting and important question. The bargaining literature is large but taxation in bargaining and models of optimal contracting with endogenous information is an unexplored topic. While it is a standard result in the literature that asymmetric information typically causes the equilibrium to be inefficient, asymmetric information is often the outcome of individual choices to invest in information acquisition. In such situations, taxation does not only affect the decision of whether to trade but also information acquisition; taking into account that information asymmetries arise endogenously can lead to different conclusions on the effects of taxation than when private information is exogenous. This topic is also relevant since bargaining, information acquisition and taxation of capital gains are present in many bilateral financial transactions such as bargaining and trade in funding markets. The main purpose of trade in decentralized funding markets is short term liquidity management The breakdown of some of these markets in the wholesale banking system was a key problem of the recent financial crisis 1 Less sophisticated market participants became concerned about endogenous lemons problems, which some market participants and regulators considered as one of the reasons for the breakdown of asset backed securities markets during the financial crisis. The financial crisis has drawn attention to a taxation of the financial sector. A theoretical analysis of the taxation of financial transactions in decentralized markets can provide important insights for the taxation and regulation of funding markets. In this paper we discuss three questions. How does taxation affect an agent's incentive to produce information and to speculate in a decentralized market? What is the effect of taxation on the equilibrium probability of trade? How does a profit tax differ from a sales tax in terms of its effects on information production and the probability of trade? To answer these questions about the effect of taxation in bilateral trade with endogenous information, we like to think of the analysis of taxation in the canonical take-it-or-leave-it-offer bargaining model as a very stylized model that captures trade of asset backed securities, an 1 The valuation of MBS requires special expertise and data intensive simulation models. More generally, hedge funds produce a large amount of information as inputs for their trading system. Information production is a key activity in security markets in which assets are information sensitive. The structure that we consider, however, is more general in that it applies to many types of bilateral trade such as buying and selling real estate properties, trade of financial assets in over-the-counter markets, mergers and acquisitions or inter-firm trade. Uncertainty and information acquisition as well as standard types of taxation play a role in most of these examples, and a positive and systematic analysis of taxation is both theoretically interesting and relevant when thinking about the behavioral reaction to taxation in decentralized markets. In our main model, we assume that some agents are sophisticated and can produce information while others are not (or have high cost of information acquisition). More specifically, we consider the case where an uninformed proposer (without private information) makes an offer to a responder who can acquire information before deciding whether to trade. While this assumption is also reflected in funding markets where some investors (e.g., hedge funds) are more capable to produce information than other investors (e.g., regional banks), the main reason for analyzing the case where an uninformed agent makes an offer is tractability. We discuss alternative information acquisition assumptions in section 6. 5 The main result of the paper is that a tax on profits and a sales (transaction) tax have opposite implications for endogenous information acquisition and trade. A (marginal) increase of a profit tax or capital gains tax can reduce the incentive to produce information and increase the probability of efficient trade. In contrast, a (marginal) increase of a sales tax can lead to more information production and lower the probability of efficient trade. Also, we show that taxation can have a direct effect on the probability of trade if, in equilibrium, there is information production, as well as an indirect effect by affecting the likelihood of information production. These results are derived in three steps. First, we consider the responder's incentives to acquire information at a given price, and we analyze how taxation affects the incentives for information acquisition. Then, we solve for the equilibrium price setting of the proposer. Finally, we show 4 Our setting is based on Dang, Gorton and Holmstrom (2012a) who analyze a model of optimal security design and sequential trade that captures some important features of trade in funding markets. Since trade in funding markets is of bilateral nature, the workhorse models (Grossman and Stiglitz 1981; 5 how taxation affects the equilibrium price chosen by the proposer (taking into account the responder's decision on information acquisition) and hence the probability of trade. We highlight the intuition behind these results for the case where an uninformed seller (e.g., a regional bank) proposes a price to sell an indivisible asset to a buyer (e.g., a hedge fund) who can produce information and then decides whether to buy at the proposed price. In terms of taxation, we consider a tax on the buyer's positive profits (where profit is defined as realized payoff of the asset minus price paid) and a sales tax on the price of the asset. First of all, while the seller obviously prefers a high price, higher prices increase the buyer's incentives to acquire information, in which case he buys the asset only for favorable signals (or in high payoff states). Therefore, the seller can either charge a low price p I , which just prevents the buyer from acquiring information, or he can charge a high price p II , accepting that the buyer will acquire information and only trade for favorable signals. 6 Compared to buying the asset without information acquisition, the buyer gains from acquiring information only in case he receives an unfavorable signal (low payoff states), for which he does not buy the asset. Therefore, the buyer's incentive to acquire information corresponds to avoiding the loss in case the true payoff of the asset is low. In such a case the value of information is not affected by a tax on positive profits. On the other hand, profit taxation reduces the buyer's gains from trade if he acquires information. Therefore, when trading with an informed buyer, the seller may have to lower the price p II in order to make the buyer participate. But lower prices lead to more trade (since an informed buyer trades with higher probability); this is what we call the direct effect of profit taxation on the equilibrium probability of trade. A second (indirect) effect of profit taxation works through the seller's choice between the prices p I and p II : Profit taxation does not affect the buyer's incentives to acquire information and hence the price p I (which just prevents information acquisition), but it may reduce the price p II which must guarantee that an informed buyer's expected gains from trade are sufficient to cover the cost of information. This makes it relatively more attractive for the seller to charge the price p I at which the buyer trades without information acquisition. In other words, profit taxation enlarges the range of cost of information for which there is no information acquisition in equilibrium but trade with probability one. 6 We assume that the seller is willing to trade with an informed buyer, e.g. because he needs to sell and raise cash. 6 For the sales tax, we also obtain a direct and an indirect effect, but here both effects are exactly the opposite. First, sales taxes may lead to a higher (tax-inclusive) price in the equilibrium with information acquisition; we show that it is optimal for the seller to shift part of the tax increase to the buyer. But a higher (tax-inclusive) price reduces the equilibrium probability of trade. Second, since the sales tax increases the (tax-inclusive) price that the buyer has to pay, it also strengthens the buyer's incentives to acquire information. Hence, if the seller wants to avoid information acquisition, he has to lower the net-of-tax price when the sales tax is increased. Overall, this makes it relatively less attractive for the seller to charge the price for which there is no information acquisition. Therefore, sales taxes enlarge the range of information cost for which there is information acquisition in equilibrium and trade with probability less than one. To summarize, sales taxes make trade less attractive and make it, therefore, less attractive to choose a price that prevents information acquisition and ensures trade with higher probability. The opposite is true for a profit tax, which makes preventing information acquisition relatively more attractive and leads to more trade. Note that, qualitatively, the effects of taxation do not depend on whether the buyer or the seller is the responder and can acquire information, even if the agents' incentives to acquire information are different: A buyer decides to acquire information in order to avoid buying the asset in low payoff states, while the seller will acquire information in order to be able to keep the asset in high payoff states. Still we show that the same effects of profit taxes and sales taxes hold in the case where the seller is the responder. The remainder of the paper is organized as follows. The next section relates the paper to the literature. Section 3 introduces the model. Section 4 provides an equilibrium analysis. Section 5 analyzes the effects of taxation on equilibrium information acquisition and pricing. Section 6 discusses the main assumptions of the paper, and Section 7 concludes. Some of the proofs are given in the Appendix. RELATED LITERATURE In many situations agents can acquire information when they bargain, contract, and trade with each other. A key insight of this strand of the microeconomic literature discussed below is that, when agents have private information, equilibrium outcomes are typically not efficient. In many bilateral transactions in secondary markets, however, rather than there being ex ante asymmetry 7 in the information that agents possess, there is asymmetry in the agents' cost or ability to acquire information. There is a relatively small number of papers that analyze information acquisition in bargaining and optimal contracting. These papers show that when information is endogenous, the equilibrium outcome can be very different from the equilibrium outcome under asymmetric information. Crémer Our paper is also related to the literature on taxation and risk-taking; for seminal contributions see In our model, however, the crucial aspect of the effect on the equilibrium price is more subtle. In particular in the case where the seller makes the offer, profit taxation does not directly change the incentives for information production but can nevertheless have an effect on the equilibrium outcome. 9 Finally, there is a growing literature on taxation of the financial sector and its impact on financial stability. A focus has been on investment decisions and portfolio choice as well as liquidity risk. Financial transaction taxes as a way to reduce speculative investments are discussed in Stiglitz (1989) and THE MODEL We consider a game with two agents: a seller S and a buyer B. The seller can sell an indivisible asset with uncertain payoff x at a price p to the buyer. Ex ante the information is symmetric; it is common knowledge that the payoff x is distributed according to the distribution function F on the F is assumed to be continuous and differentiable on [x L , x H ]. As will be described below, there will be the possibility to acquire information at a cost γ 0. The ex post utility of agent i = S,B is given by indicates whether there is trade (q = 1 if the asset is traded and q = 0 otherwise) and the indicator variable 1 info indicates whether agent i has acquired information (at cost γ). Specifically, we consider the following objective functions: Here, v i (x) is agent i's valuation of the asset, which is assumed to be continuous and strictly increasing in the asset's payoff x. Moreover, κ 0 is a per unit sales tax to be paid by the buyer. Hence, κ increases the tax-inclusive price from p to p+κ. Finally, represents a tax payment on positive monetary profit y net of some amount z 0, which is deductible for tax purposes. More specifically, agent i makes a positive profit if the realized payoff of the asset is larger than the price paid for the asset; in this case, these positive profits are taxed at rate For the buyer, a positive profit occurs if he buys the asset and the payoff of the asset is larger than the price p. The seller's profit may be subject to taxation either if he does not sell the asset and realizes a payoff x that is larger than some price p 0 that he initially paid for the asset (the 'book value') or if he sells the asset and receives a price p that is larger than the 'book value' p 0 . This 'book value' p 0 represents a cost that may be deductible for tax purposes and we assume that 0 ≤ p 0 < x H . Given u S (x,p,q) and u B (x,p,q), the outside options of seller and buyer are We make the following assumption: This assumption implies that trade is efficient since the buyer derives a higher value from holding the asset than the seller. 10 We analyze a simple bargaining game where one of the agents -the proposer P -offers a price; the other agent -the responder R -can acquire information (at cost γ) to learn about the true realization of x and then decides whether to trade. We assume that and we only consider a tax on the responder's monetary profit which, due to v R (x) = x, is equal to his utility u R . 11 We briefly provide a motivation of the main assumptions of the model which is supposed to capture trade in decentralized funding markets, specifically the trade of asset backed securities. 10 This assumption ensures that the parties have an incentive to trade and is fulfilled, for instance, if the seller needs to raise cash and the buyer wants to store cash by investing in the asset. 11 Hence, the responder's gains from trade coincide with the monetary profit subject to taxation. By ignoring a tax on the proposer's profit we can isolate the effect of taxation on the responder's incentives to produce information. but not all traders can produce information about the payoff of the asset. We argue that large banks and hedge funds are more sophisticated and capable to produce information than regional banks and cash managers of corporations. 12 (iv) For tractability, we assume that only the responder can acquire information. Section 6 discusses alternative information acquisition assumptions. EQUILIBRIUM ANALYSIS The analysis proceeds in two steps. First, we consider the responder's incentives to acquire information and his best reply to a given price p. Second, we derive the equilibrium price chosen by the proposer. We use these results to analyze the effect of profit taxation and sales taxes on the responder's incentives to acquire information and the consequences for the equilibrium price and trade in the next section. Incentives for information production Observing a price p chosen by the proposer, the responder has three options. He can decide not to trade (choose his outside option), he can trade at price p without information production, and he can acquire information and decide whether to trade conditional on the information received. The responder's "value of information" depends on the alternative option he considers to choose. 12 For example, even though all investors have access to documents about asset backed securities (ABS), a small bank is less capable than hedge funds to produce information about the payoff of ABS because the valuation of these structured products requires special expertise and data intensive simulation models. 12 Definition 1 (Value of information) The function q* in Definition 1(i) describes the optimal decision rule according to which an informed responder trades: He chooses q = 1 if and only if his utility from trading is larger than his utility from not trading, knowing the price and the true payoff x. Second, V I is defined as the responder's expected utility conditional on knowing the true payoff x of the asset (and deciding to trade according to q*), minus his expected utility if he trades with probability one. Hence, V I is the responder's value of information when deciding between information acquisition and trading without information acquisition (q = 1). Third, V II is defined as the responder's expected utility conditional on knowing the true payoff x minus his expected utility if he does not trade at all. In other words, V II is the responder's value of information when deciding between information acquisition and not trading at all without information acquisition (q = 0). 13 Observation 1 below is useful for the proof of subsequent results and therefore stated here explicitly. . An uninformed responder does not trade if V I (p) > V II (p). In the absence of taxation, V I Since v R (x) = x, an uninformed responder is indifferent between trading and not trading if the price is equal to the expected payoff of the asset. 13 Dang, Gorton and Holmstrom (2012a,b) introduce the terminology "information sensitivity" for the value of information in a setting without taxation. To summarize, compared to the option of trading uninformed, the buyer would like to acquire information in order to avoid a loss when buying the asset at a too high price, while the seller would like to acquire information in order to avoid to have sold the asset at a too low price. In contrast, compared to the option of not participating, the buyer's value of information is the gain from buying in high payoff states, while the seller's value of information is the gain from selling in low payoff states at a higher price. 13 Before we solve for the responder's best reply given a price p, the following lemma summarizes comparative statics results on the incentives for information production. Recall that the buyer has to pay a sales tax κ 0, and hence the buyer's utility when buying depends on the tax-inclusive price p+κ (compare the definition of u B (x,p,q) above), while the seller's utility depends on the net-of-tax price p. Lemma 1 (Comparative statics of V I ) If the buyer is the responder, then V I is (a) strictly increasing in the price p, (b) independent of the profit tax τ, and (c) strictly increasing in the sales tax κ. (ii) Suppose that p < x H . If the seller is the responder, then V I is (a) strictly decreasing in the price p, (b) strictly decreasing in the profit tax τ, and (c) independent of the sales tax κ. Proof: See Appendix. 15 The comparative statics results for price p and sales tax κ on V I can be highlighted with The effect of the profit tax is illustrated in Proof: See Appendix. 14 We will discuss the effect of a loss offset on our main results in Section 6. For the seller, V II represents his gain from selling the asset in low payoff states (where x < p). 16 This gain is higher the higher the price p that the seller receives, but it is reduced if the profit tax is increased, as the information rent (the difference between p and x) is subject to taxation. The latter effect is illustrated in The optimal choice of the responder The properties of V I and V II can be used to determine the best reply of the responder. Facing a price p, the optimal decisions on information production and trading can directly be characterized as a function of the information cost γ. We as

Essays on information acquisition

Informationsverhalten ; Verhandlungstheorie ; Asymmetrische Information ; Wertpapierhandel ; Pareto-Optimu

Bargaining with endogenous information

This paper analyses information acquisition in ultimatum bargaining with common values. Because of an endogenous lemons problem the equilibrium payoffs of the agents are non-monotonic in the information cost. The mere possibility of information acquisition can cause no trade although the agents maintain symmetric information in equilibrium and the gain from trade is common knowledge. The agent responding to a take-it-or-leave-it offer may capture some or even the full trading surplus in a perfect Bayesian equilibrium. The implications for sequential bargaining are discussed.