Good News and Bad News: Representation
Theorems and Applications
Paul R. Milgrom
2/11/2016
Presented by Daniel Bird
Good News and Bad News: Representation Theorems and Applications
Main Question
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Theory: How to model ”favorable” news?
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Accounting: When do firms disclose (verifiable) information?
Good News and Bad News: Representation Theorems and Applications
Main Contribution
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Predict that firm’s voluntarily disclose all their verifiable
private information
Good News and Bad News: Representation Theorems and Applications
Model - 1
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Players:
1. Firm
2. Market
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Firm’s value belongs to the set {s1 , s2 , . . . , sN }, si < si+1
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Ex-ante value is distributed F (s)
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Objectives:
1. Firm: Maximize the market’s assessment of the firm’s value
2. Market: Asses firm’s value correctly
Good News and Bad News: Representation Theorems and Applications
Model - 2
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The game:
1. Firm learns its realized value
2. Firm may disclose its value
3. Market assesses firm based on available information (disclosed
value or decision to not disclose)
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Solution concept: a version of sub-game perfect equilibrium
Good News and Bad News: Representation Theorems and Applications
Main Result
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In any equilibrium, firms disclose all values above s1
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I.e., market learns the firm’s value
Good News and Bad News: Representation Theorems and Applications
Intuition-1
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For simplicity, assume three possible values.
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Evaluation conditional on non-disclosure is a weighted average
of s1 , s2 and s3
1. It is optimal for firm s3 to withhold information only if market
believes non-disclosing firms are of type s3
2. ⇒ Firms s1 , s2 will avoid disclosure to receive a valuation of s3
3. ⇒ The belief that non-disclosing firms are of type s3 is not
part of any equilibrium
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A firm of type s3 must disclose in any equilibrium
Good News and Bad News: Representation Theorems and Applications
Intuition-2
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As s3 discloses, evaluation conditional on non disclosure is a
weighted average of s1 and s2
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By the same logic as before firm s2 will disclose in equilibrium
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Valuation conditional on non-disclosure is s1 . Firm’s of type
s1 are indifferent about disclosing
Good News and Bad News: Representation Theorems and Applications
Main Weakness
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Main prediction is not observed in real world
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Assumptions on information structure are too strong
Good News and Bad News: Representation Theorems and Applications