Disclosure as a tool for building trust and stimulating investment

This study analyses the role of disclosure in trust settings. It examines both theoretically and experimentally how the opportunity to make voluntary disclosures enhances the building of trust and trustworthiness to facilitate institutions for exchange and investment. If there are some trustworthy managers who always disclose their private information (or there is simply a belief that there are some trustworthy managers), then a sequential equilibrium predicts that a rational manager will choose to disclose her private information in an attempt to earn a reputation for being trustworthy. However, the manager does so selectively instead of indiscriminately in order to ensure credibility associated with her choice. By allowing for such reputation building, an economy with disclosure will have higher investment as compared to one without disclosure. Disclosure allows rational agents to develop a reputation for being trustworthy types and thereby sets stage for greater investor confidence resulting in higher investment. A rational manager's strategic choice of selectively mimicking a trustworthy manager is corroborated by the experimental data. The experiment also introduces a screening round to identify trustworthy managers and thereby enable comparison of investment in economies with identical proportion of trustworthy agents but different disclosure institutions. The data corroborates higher investment in economies with disclosure.