Broken Telephone Communication

The existing literature on corporate voluntary disclosures largely focuses on studying direct information transfers from publicly traded firms to capital market investors, ignoring the presence of information intermediaries (such as auditors, audit committees, appraisers, actuaries, and legal experts) in the communication process. Addressing this gap in prior literature, the paper studies strategic voluntary information transfers from firms to investors through intermediaries. In such indirect communication, referred to in the study as broken telephone communication, the transmitted information is transformed along the way from the sender to the receiver. As in the well-known children's game, each intermediary in the communication chain alters the transmitted information, distorting or alternatively purifying it, so that the information investors eventually receive differs from the information the firm originally delivered. An analysis of a broken telephone communication game, which extends the conventional voluntary disclosure framework by incorporating an information intermediary, yields the surprising result that broken telephone communication channels are more effective than direct communication channels in encouraging firms to voluntarily convey their private information to capital market investors. Furthermore, the more broken and disruptive the communication channel, the stronger the propensity of firms to voluntarily deliver information to investors. Hence, there exists an interesting endogenous balance between the quality and the quantity of information that passes through broken telephone communication channels. So, although broken telephone communication channels frequently have the destructive effect of distorting the quality of the transmitted information, they also have a counterintuitive compensatory effect of enhancing the quantity of the transmitted information.