Risk Information, Investor Learning, and Informational Feedback

This paper studies how public information regarding a firm’s riskiness affects investors’ incentives to acquire information about the firm and the firm’s ability to learn decision-useful information from its price. I find that risk information complements investor learning by informing investors of when it is most lucrative to investigate the firm, thereby reducing liquidity. Furthermore, risk information causes the firm’s price to contain more information when the firm’s investment decisions have the greatest impact on its value, thereby improving real efficiency. Extensions of the model suggest that the impact of risk information on real efficiency may deteriorate when the firm’s manager is excessively exposed to idiosyncratic risk, when the firm’s shareholders are excessively averse to such risk, or when the disclosure concerns a “downside risk.” In sum, my analysis suggests that information regarding firms’ expected values and information regarding firms’ risks significantly differ in their effects on the capital market.