When It Comes to Half-Truths, No News Is Bad News

Voluntary disclosures, like those issued by managers in quarterly earnings calls, inform investment decisions across financial markets. They can buoy — or puncture — corporate valuations and stock prices. But it isn’t always clear what effects result from the policies governing these disclosures, especially when it comes to rules about half-truths and the duty to update.

In a new article in Management Science, Anne Beyer, a professor of accounting at Stanford Graduate School of Business, and Ronald Dye of Northwestern’s Kellogg School of Management, use static and dynamic models to understand the effects of regulation on both voluntary corporate disclosure policies and the investors who depend on them.

Half-truths are disclosures that are true in and of themselves but misleading in light of other information managers know but choose to withhold. For example, if a company announces that it will be losing one of its major customers but doesn’t mention that it’s also aware that another major customer is likely to leave, that would be a half-truth. These kinds of omissions are illegal under federal securities law, but their definition is not universally agreed upon. This creates loopholes that can make it difficult to hold managers legally accountable for skirting the whole truth.

Legality aside, whether permitting half-truths in disclosures is preferable to prohibiting them is an open question. Many disclosure regulations aim at providing transparency for investors and other stakeholders. However, it is not self-evident whether barring managers from issuing half-truths leads them to disclose more information.

On the one hand, if a prohibition of half-truths is enforced, then a firm that wants to make a disclosure must disclose the entire truth and cannot selectively withhold part of the relevant information. This may cause the firm to not make any disclosure. On the other hand, if half-truths are allowed, a firm may be willing to share some information on a topic that it would be unwilling to share if full disclosure was required.

Truth or Dare

Beyer and Dye employed a static theoretical model to investigate this question. It assumed that a manager has two different pieces of value-relevant information and wants to maximize investors’ perception of firm value. The model reveals that, in equilibrium, when half-truths are prohibited, managers will offer a wider array of information and become less selective about voluntary disclosures.

This somewhat counterintuitive finding is a result of the number of options managers have when half-truths are allowed. In this scenario, managers can disclose all the information they have, part of it, or none of it. If half-truths are prohibited, managers can only disclose all or none of the information. “So, if half-truths are allowed, the manager has two options to hide comprehensive news by disclosing nothing or disclosing half-truths. But if I can’t use half-truths, my options narrow,” Beyer explains.

The intuition carries over even to situations where managers do, in fact, disclose all the information they have. When half-truths are allowed, investors will view any disclosure with skepticism since it’s always possible that managers have additional unfavorable information they’re withholding. In contrast, if half-truths are prohibited, investors do not have to consider these kinds of selective disclosures, which increases the credibility of management disclosures.

In this situation, Beyer says, “As an investor, I know that you can’t hide anything from me in the sense of giving me a half-truth. So, if this is what you’re disclosing, this must be all you’ve got, and I don’t have to be as skeptical about it. Taking away the option of a half-truth makes any disclosure more credible and, in that sense, more valuable.” If investors react less skeptically, managers deem less-positive news “sufficiently good” to warrant disclosure and, as a result, become less selective about voluntary disclosure.

The Dynamics of Disclosure

Beyer and Dye extended their study to analyze the effects of a “duty to update” on voluntary management disclosures. This duty, established in federal securities law, obligates management to revise a prior disclosure if new, contradictory information becomes available. For example, when Elon Musk tweeted in 2018 that he was considering taking Tesla private at $420 per share and had secured the necessary funding, he likely triggered a duty to update when he abandoned the plan.

A duty to update is generally considered a legal obligation, although some courts do not recognize it. And here, too, certain conditions can create loopholes. If, for instance, the original information was vaguely stated or if the reliability of the new information is questionable, there is currently no duty to update.

“In many ways, a duty to update is similar to half-truths; it just occurs over time,” Beyer says. In this case, the researchers used a dynamic model in which the pieces of value-relevant information the manager receives arrive in two different periods, and the manager’s goal is to maximize the stock price at all times. As expected, imposing a duty to disclose increases the amount of information management offers in the second period. Less expectedly, however, Beyer and Dye found that a duty to update does not change the amount of information that management offers in the first period of their model, inconsistent with concerns that imposing a duty to update might cause companies to make fewer initial disclosures.

While truth, trust, and transparency are increasingly important issues in the business world and financial markets, Beyer is reluctant to use the conclusions she and Dye draw from their models as a basis for policy recommendations.

“For me, the purpose of the models was to enable us to make a stringent argument of those economic forces we capture, not to reflect all economic forces that may be at play,” she says. “For example, investors may not be fully rational, not even on average, and that’s not something we capture in the model.” But that doesn’t mean the model doesn’t offer some important insight into the complexities of disclosure. “Now, if we were to find our predictions don’t hold up in the real world, we know that it’s because some additional economic forces must be at play.”