Fixing the Proprietary Cost Assumption in Discretionary Disclosure Models

ABSTRACT I present a critique of the common assumption of fixed proprietary costs in discretionary disclosure models, which are frequently used to motivate and interpret empirical analyses of voluntary disclosures in capital market settings (e.g., management guidance, segment performance, and major customers). In a fairly general model, proprietary costs that are fixed (i.e., independent of the disclosed information) are contradictory to their proprietary nature. To sustain informational independence requires either that the party (e.g., competitor) imposing proprietary costs on the disclosing firm is indifferent to the information or that the disclosing firm is indifferent to what the competitor/counterparty will do with the information. Either of these is inconsistent with a plain interpretation of proprietary disclosure costs, which arise precisely because of responses to disclosed information. I suggest that researchers should explicitly consider how the disclosed information will be used rather than derive predictions or interpret results based on information-insensitive proprietary costs. JEL Classifications: D21; G32; M41.